Chapter 10 Making Capital Investment Decisions
Key concepts and skills
Project Cash Flows
Relevant Cash Flows
The Stand-Alone Principle
Incremental Cash Flows
Sunk Costs
Opportunity Costs
Side Effects
Net Working Capital
Financing Costs
Other Issues
Pro Forma Financial Statements and Project Cash Flows
Getting Started: Pro Forma Financial Statements
Project Cash Flows
Projected Total Cash Flow and Value
More about Project Cash Flow
A Closer Look at Net Working Capital
Depreciation
Evaluating Equipment Options with Different Lives
Project Cash Flows
Relevant Cash Flows
Cash flows that occur (or don 't occur) because a project is undertaken. Cash flows that will occur whether or not we accept a project are not relevant.
Incremental cash flows
Any and all changes in the firm 's future cash flows that are a direct consequence of taking the project
Note: A project 's cash flows imply changes in future firm cash flows and, therefore, in the firm 's future financial statements. Below are a couple examples of possible projects that would suggest consideration of an incremental item.
1) The development of a plant on land currently owned by the company versus the same development on land that must be purchased. This example leads to a discussion of opportunity cost.
2) Consider the tax shelter provided by depreciation: What is the relevant depreciation effect if we replace an old machine with a three-year remaining life and $5,000 per year depreciation? Suppose the new machine will cost $45,000 and will be depreciated over a 5-year life with straight-line depreciation. The depreciation expense on the new machine would be $9,000 per year. Assume a tax rate of 40%. Therefore, the incremental depreciation expense for the first three years is $4,000, leading to a depreciation tax shield of $4,000(.4) = $1,600. The incremental depreciation tax shield for years 4 and 5 is $9,000(.4) = $3,600.
Problems: 1 and 2, pp. 327 – 328
The Stand-Alone
Project Cash Flows
Relevant Cash Flows
The Stand-Alone Principle
Incremental Cash Flows
Sunk Costs
Opportunity Costs
Side Effects
Net Working Capital
Financing Costs
Other Issues
Pro Forma Financial Statements and Project Cash Flows
Getting Started: Pro Forma Financial Statements
Project Cash Flows
Projected Total Cash Flow and Value
More about Project Cash Flow
A Closer Look at Net Working Capital
Depreciation
Evaluating Equipment Options with Different Lives
Project Cash Flows
Relevant Cash Flows
Cash flows that occur (or don 't occur) because a project is undertaken. Cash flows that will occur whether or not we accept a project are not relevant.
Incremental cash flows
Any and all changes in the firm 's future cash flows that are a direct consequence of taking the project
Note: A project 's cash flows imply changes in future firm cash flows and, therefore, in the firm 's future financial statements. Below are a couple examples of possible projects that would suggest consideration of an incremental item.
1) The development of a plant on land currently owned by the company versus the same development on land that must be purchased. This example leads to a discussion of opportunity cost.
2) Consider the tax shelter provided by depreciation: What is the relevant depreciation effect if we replace an old machine with a three-year remaining life and $5,000 per year depreciation? Suppose the new machine will cost $45,000 and will be depreciated over a 5-year life with straight-line depreciation. The depreciation expense on the new machine would be $9,000 per year. Assume a tax rate of 40%. Therefore, the incremental depreciation expense for the first three years is $4,000, leading to a depreciation tax shield of $4,000(.4) = $1,600. The incremental depreciation tax shield for years 4 and 5 is $9,000(.4) = $3,600.
Problems: 1 and 2, pp. 327 – 328
The Stand-Alone