Chapter Net Present Value and Capital Budgeting 7.2 Incremental cash flows 7.2.1 Sunk costs A cost that has already been incurred and and can not be removed and therefore should not be considered in an investment decision 7.2.2 Opportunity cost The most valuable alternative that is given up if a particular investment is undertaken. 7.2.3 Side effects Erosion is the cash flows of a new project that come at the expense of all firms existing projects
Chapter 7 Net Present Value and Capital Budgeting 7.2 Incremental cash flows 7.2.1 Sunk costs A cost that has already been incurred and and can not be removed and therefore should not be considered in an investment decision. 7.2.2 Opportunity cost The most valuable alternative that is given up if a particular investment is undertaken. 7.2.3 Side effects • Erosion is the cash flows of a new project that come at the expense of all firm’s existing projects
Chapter Net Present Value and Capital Budgeting 7.2.4 Net working capital 7.2.5 Financing costs Some conclusions of incremental cash flows When we estimate cash flows on an incremental basis, we should learn by heart that Do not confuse average with incremental payoffs Include all incidental effects Do not forget working capital requirements Include opportunity costs. Forget sunk costs Beware of allocated overhead costs
Chapter 7 Net Present Value and Capital Budgeting 7.2.4 Net working capital 7.2.5 Financing costs Some conclusions of incremental cash flows When we estimate cash flows on an incremental basis, we should learn by heart that • Do not confuse average with incremental payoffs. • Include all incidental effects • Do not forget working capital requirements. • Include opportunity costs. • Forget sunk costs • Beware of allocated overhead costs
Chapter 7 Net Present value andr Capital Budgeting 7.3 Pro forma financial statements and project cash flows The first thing we need when we begin evaluating a proposed investment is a set of pro forma or projected financial statements. 7.3. 1 Getting started: pro forma financial statements Pro forma financial statements are those financial statements projecting future years operations
Chapter 7 Net Present Value and Capital Budgeting 7.3 Pro forma financial statements and project cash flows The first thing we need when we begin evaluating a proposed investment is a set of pro forma or projected financial statements. 7.3.1 Getting started: pro forma financial statements • Pro forma financial statements are those financial statements projecting future years’ operations
Chapter 7 Net Present Value and Capital Budgeting/ To prepare these statements, we will need estimates of quantities such as unit sales, the selling price per unit, the variable cost per unit, and total fixed costs We also need to know the total investment required including any investment in net working capitaL. Suppose we think we can sell something 50000cans per year at a price of $4.00per unit. It costs us about $2. 50per can, and a new product such as this one has only a three-year life. We require a 20% return on new products. The other factors are given like the next page
Chapter 7 Net Present Value and Capital Budgeting To prepare these statements, we will need estimates of quantities such as unit sales, the selling price per unit, the variable cost per unit, and total fixed costs. We also need to know the total investment required, including any investment in net working capital. Suppose we think we can sell something 50000cans per year at a price of $4.00per unit. It costs us about $2.50per can, and a new product such as this one has only a three-year life. We require a 20% return on new products. The other factors are given like the next page
Chapter Net Present Value and Capital Budgeting Projected income statements of special firm S ales $200000 Variables costs 125000 75000 Fixed costs 12000 Depreciation 30000 EBIT 33000 Taxes (34%) 11220 Net income 21780
Chapter 7 Net Present Value and Capital Budgeting Projected income statements of special firm Sales $200000 Variables costs 125000 75000 Fixed costs 12000 Depreciation 30000 EBIT 33000 Taxes (34%) 11220 Net income 21780