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25 Cards in this Set
- Front
- Back
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In principle, how are the cash flows of a project deemed relevant? |
If the project's cash flow changes the firm's future overall cash flows. |
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Define: incremental cash flows |
Any and all changes in the firm's future cash flows from taking the project. |
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Which cash flows are irrelevant for a project? |
Cash flows which exist regardless of taking a project, or not. |
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Define: stand-alone principle |
A project can be evaluated solely on its incremental cash flows and in isolation from any other activities. |
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Define: sunk cost |
Costs which have been incurred and unrecoverable, implying that it should not be considered for investment decisions. |
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Define: opportunity cost |
The value foregone of the next best alternative by the consumption of a good (or taking a project). |
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Define: erosion |
The cash flows of a new project that comes at the expense of other existing projects, only when they would be lost as a direct consequence of the new project. |
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What is the true objective of project evaluation? |
Comparison of a project's cash flow to that of its costs in order to estimate the net present value. |
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How is erosion relevant for project evaluation? |
This is because erosion, which is the decrease in value of current projects as a direct result of taking a new one, will also decrease the firm's overall future cash flows. |
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Why aren't dividends, or interest paid irrelevant for project evaluation? |
Because the incremental cash flows are the operating ones, which do not include financing expenses. |
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Define: pro forma financial statements |
Financial statements projecting future years' operations. |
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What are the three components of asset cash flow? Hence, what is the formula for the project's cash flow? |
1. Operating Cash Flow 2. Capital Spending 3. Changes in Net Working Capital Operating Cash Flow - (Capital Spending + Changes in Net Working Capital) |
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How are operating cash flows calculated? |
EBIT + Depreciation - Taxes |
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How are investments in net working capital calculated? |
The same amount has to appear at some future time, with the opposite sign. |
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Why is depreciation added to operating cash flows, regardless of whether it is not an actual cash expense? |
Because depreciation reduces taxable income. |
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By the Tax Shield Approach, how are the Operating Cash Flows calculated? |
OCF = Gross Profit + Depreciation Tax Shield |
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Define: depreciation tax shield (formula) |
The tax savings from deductions of depreciation. Depcreciation * Corporate Tax Rate. |
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How do operating cash flows differ from net income? |
Mainly by depreciation as it is not a cash expense. |
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Why is the initial investment of the net working capital calculated back? |
The initial investment tied to the project is recovered at the end. |
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Why are changes in net working capital implemented into the operating cash flows? |
Because accounting cash flows are not necessarily the actual cash flows. E.g. accounts receivable are yet to be received and payables yet to be paid. |
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Formula: net working capital |
Current assets - current liabilities |
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In principle, what is the relationship between the change in net working capital and operating cash flows? |
Inverse relationship. |
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Using the net income, how is the cash flow calculated for the current year? |
Net income + Non-cash expenses (e.g. depreciation) - Net investments in long-term capital +/- changes in net working capital |
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What happens to the initial investment in capital spending after the project, given that it has salvage value. Hence, what happens to the project cash flow? |
It is sold at its after-tax market value, which increases the project cash flow at the year it is sold. |
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What happens to the remaining net working capital at the end of the project's life? Hence, what happens to the project cash flow? |
It assumed it will be recovered at the end of the project's life. This increases the project's cash flow at the year. |
