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Flashcards in Capital Budgeting Deck (10):

Capital Budgeting

Process for evaluating and selecting the long-term investment projects of the firm


Cash Flow Effects: Direct effect

Pays out cash & receives cash


Cash Flow effect: Indirect effect

Net proceeds on sale of old reduces cost of new


Cash Flow: Depreciation

Depreciation reduces the amount of taxable income.
Depr. X Tax Rate= $ that you are saving


Buying Working Capital

Treated as a cash outflow, you are practically buying assets


Reduced Working Capital requirements

You are selling an asset. that is cash in flow


Disposal of a replaced asset

Offsets the cost of the new asset.
Selling Price- Net Book Value= Gain or Loss
If you sell at a gain. You have to subtract the tax out of the gain.
-Gain X T out
+ Loss X T In


Net Initial cost of an asset

Invoice+ Shipping+ Install = Out
+ Increase in Working Capital= Out
-Net Proceeds sale of old asset= Inflow
= Net Inflow


What is a limitation of the profitability Index?

It requires detailed long-term forecasts of the project's cash flows.


The basic objective of the residual income approach of performance measurement and evaluation is to have a division maximize its

Income in excess of a desired minimum amount