25300 Lecture 8: Lecture 8 - Capital Budgeting 2
Decide the relevant cash flows
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Cash flow and accounting profit are not equivalent
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Timing
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Compared to revenue and expenses
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Pay attention to:
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Identify the incremental cash flows
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Capital budgeting is done before the event
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Cash flows is done after the event
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Cash flows
The beginning or the end of the year only
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Cash flow timing is exactly a multiple of year
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Three categories: at the start, over the life, at the end
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Cash flow timing
At the beginning of a project's life (initial cash flows)
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Not only the purchase of plant and equipment
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Establishment expenses
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The sale of the old machine
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Investment in working capital
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Market value of assets owned that are to be used in the project (the opportunity cost)
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Other relevant cash flows:
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Cash flows an asset could generate if not used in a proposed investment
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An asset's market value
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Opportunity cost:
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Is an expense paid previously, cannot be recovered (R&D expenses)
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A cost that is incurred regardless of today's investment decision
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Should not be included in the project capital budgeting
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Sunk cost:
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CASH FLOWS AT THE START
Incremental cash flows: changes in cash flows that occur from accepting the project
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Will the amount of the cash flow item change if the project is accepted?
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A cash flow that occurs regardless of whether an investment proceeds or does not proceed is not
incremental
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Identifying cash flows:
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The required rate of return used to calculate NPV
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Interest payments and other financing cash flows should not be included in capital budgeting
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Do not include anything related to DEBT & EQUITY
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Financing costs
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Effect of tax -> SHOULD BE CONSIDERED
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Assume tax is paid in the year the liability is incurred
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All operating revenue is taxable and all operating costs are tax deductible
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Purchase of assets are not tax deductible at the time of purchase but depreciation is allowed as a
tax deduction
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Taxes:
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Not a cash outflow but is tax deductible
Depreciation and tax:
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Operating cash flow:
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CASH FLOWS OVER THE LIFE
Lec 8 Capital Budgeting 2
F Page 19
Document Summary
Cash flow and accounting profit are not equivalent. Cash flow timing is exactly a multiple of year. The beginning or the end of the year only. Three categories: at the start, over the life, at the end. At the beginning of a project"s life (initial cash flows) Not only the purchase of plant and equipment. Market value of assets owned that are to be used in the project (the opportunity cost) Cash flows an asset could generate if not used in a proposed investment. Is an expense paid previously, cannot be recovered (r&d expenses) A cost that is incurred regardless of today"s investment decision. Should not be included in the project capital budgeting. Incremental cash flows: changes in cash flows that occur from accepting the project. A cash flow that occurs regardless of whether an investment proceeds or does not proceed is not incremental. The required rate of return used to calculate npv.
