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Capital Budgeting and Cash Flow

Capital Budgeting and Cash Flow. Capital Budgeting is the allocation of a scare resource (money) to a set of projects Objective - Maximize Benefits Understand the level of risk First Step is to measure Cash Flow Incremental Cash Flow Only Step Two - Build Financial Data

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Capital Budgeting and Cash Flow

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  1. Capital Budgeting and Cash Flow • Capital Budgeting is the allocation of a scare resource (money) to a set of projects • Objective - Maximize Benefits • Understand the level of risk • First Step is to measure Cash Flow • Incremental Cash Flow Only • Step Two - Build Financial Data • Step Three - Select project(s) • We have already seen Chapter 10 on models

  2. Capital Budgeting – Cash Flow • Terms • Independent and Mutually Exclusive Projects • Limited Capital Funds (Scare Resource) • Accept vs. Reject Decision • Ranking Potential Projects • Conventional Cash Flow Patterns • Investment up front, benefits follow later

  3. Capital Investment Decisions • Step one: Projecting Cash Flows • Incremental Cash Flows Only • Shared or Common Costs • Sunk Costs • Opportunity Costs • Erosion • Net Working Capital • Problem 3

  4. Capital Investment Decisions • Step Two - Pro Forma Statements • What is the investment cash flow? • Installed Asset Approach – Capital Spending • What is the benefit cash flow? • building operating cash flow from accounting statements • depreciation expense (why non cash flow?) • Chapter 3, pages 87-97 • do not deduct interest expense, it is in the discount rate

  5. Capital Investment Decisions • Terminal Cash Flow • Shutting down the project generates cash flow • Salvage Value of Property and Unused Depreciation • Net Working Capital (start and finish) • Problem 17

  6. Capital Budgeting – Cash Flows • Relevant Cash Flows • Problem 18, Chapter 9 • Note initial investment is a tax-deductible item, and includes the installation costs • Note we are only concerned with the changes in cash flow – not the total cash flow, thus revenues and other expenses remain the same • What is the decision that we are going to make? • Go or No-go on the equipment • Sensitivity Analysis with Problem 18

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