Fin323 Ch. 8, Capital Budgeting Cash Flows

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Capital Budgeting

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the process of evaluating and selecting long-term investments that are consistent with the firm's goal of maximizing owner wealth.

firms treat capital budgeting (investment) and financing decisions separately

is the process of identifying, evaluating, and implementing a firm’s
investment opportunities.
• It seeks to identify investments that will enhance a firm’s competitive advantage and
increase shareholder wealth.

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capital expenditure

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an outlay of funds by the firm that is expected to produce benefits over a period of time greater than 1 year.

fixed-asset outlays are captial expenditures

motives for capital expenditures are to expand, replace, or renew fixed assets

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capital expenditures:

expansion

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most common motive for capital expenditures is to expand level of operations. growing firm often needs to acquire new fixed assets rapidly, as in a purchase of property and plant facilities

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replacement or renewal

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capital expenditures made to replace or renew obsolete or worn out assets. benefit of replacement should be consider if it is better than repair

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other purposes

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some involve long-term commitment of funds in expectation of a future return. ex. research and development, management consulting, and new products.

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independent projects

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projects whose cash flows are unrelated or independent of one another; the acceptance of one does not eliminate the others from further consideration.

on the other hand, do not compete with the firm’s resources. A
company can select one, or the other, or both—so long as they meet minimum
profitability thresholds.

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mutually exclusive projects

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are those that have the same function and therefore compete with one another. accepting any one option eliminates the need for either of the others.

are investments that compete in some way for a company’s
resources—a firm can select one or another but not both.

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capital rationing

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the financial situation in which a firm has only a fixed number of dollars available for capital expenditures, and numerous projects compete for these dollars.

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conventional cash flow patterns

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an initial outflow followed only a series of inflows.

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nonconventional cash flow pattern

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an initial outflow followed by a series of inflows and outflows

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independent projects

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projects whose cash flows are unrelated or independent of one another; the acceptance of one does not eliminate the others from further consideration.

on the other hand, do not compete with the firm’s resources. A
company can select one, or the other, or both—so long as they meet minimum
profitability thresholds.

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mutually exclusive projects

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are those that have the same function and therefore compete with one another. accepting any one option eliminates the need for either of the others.

are investments that compete in some way for a company’s
resources—a firm can select one or another but not both.

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capital rationing

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the financial situation in which a firm has only a fixed number of dollars available for capital expenditures, and numerous projects compete for these dollars.

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conventional cash flow patterns

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an initial outflow followed only a series of inflows.

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nonconventional cash flow pattern

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an initial outflow followed by a series of inflows and outflows

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relevant cash flows

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the incremental cash outflow (investment) and resulting subsequent inflows associated with a proposed capital expenditures

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incremental cash flow

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represent the additional cash flows - outflows or inflows- expected to result from a propoased capital expenditure

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conventional pattern:

initial investment

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teh relevant cash outflow for a proposed project at time zero

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conventional pattern:

operating cash inflows

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the incremental after-tax cash inflows resulting from implementation of a project during its life

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conventional pattern:

terminal cash flow

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the after-tax nonoperating cash flow occurring in the final year of a project. it is usually attributable to liquidation of the project.

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relevant cash flows: expansion versus replacement decisions

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Estimating incremental cash flows is relatively straightforward in the case of expansion
projects, but not so in the case of replacement projects.
• With replacement projects, incremental cash flows must be computed by subtracting
existing project cash flows from those expected from the new project.

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sunk costs

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cash outlays that have alreday been made (past outlays) and therefore have no effect on the cash flows relevant to a current decision.

sunk costs should not be included in a project's incremental cash flows

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opportunity coats

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cash flows that could be realized from the best alternative use of an owned asset.

opportunity costs, which are cash flows that could be realized from the best
alternative use of the asset, are relevant.

opportunity costs should be included as cash outflows when one is determining a project's incremental sash flows

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installed cost of new asset

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installed cost of new asset - after-tax proceeds from sale of old asset = initial investment

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cost of new asset

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the net outflow necessary to acquired a new asset

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installation costs

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any added costs that are necessary to place an asset into operation

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installed cost of new asset

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teh cost of new asset plus its installation costs; equals the asset's depreciable value.

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after-tax proceeds from sale of old asset

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are the net cash inflows it provides.

= proceeds from sale of old asset (cash inflows, net of any removal or cleanup costs, resulting from the sale of an existing asset) - tax on sale of old asset

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book value

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strict accounting value of an asset, calculated by subtracting its accumulated depreciation from its installed cost

book value = installed cost of asset - accumulated depreciation

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basic tax rules

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gain on sale of asset where sale price is greather than book value... all gain above book value are taxed as ordinary income.

loss on sale of asset where amount by which sale price is less than book value. if the asset is depreciable and used in business, loss is deducted from ordinary income. no deductible if not a business or depreciable...loss only deductible against capital gains (money out of ur pocket)

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recaptured depreciation

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the portion of an asset's sale price that is above its book value and below its initial purchase price.

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net working capital

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the amount by which a firm's current assets exceed its current liabilities

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change in net working capital

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the difference btw a change in current assets and a change in current liabilities.

change in net working capital - regardless of whether it is an increase or a decrease - is not taxable because it involves a net buildyup or net reduction of current accounts.