Topic 6 - Project Cash Flows Flashcards
(10 cards)
What are Incremental Cash Flows
Cash flows that arise only because a project is undertaken - the difference between cash flows with and without the project
What is the Standalone Principle
Evaluate a project based on its incremental cash flows only, in isolation from the firm itself
Which costs are Relevant or Irrelevant under the stand-alone principle
Relevant:
- Opportunity costs
- Side effects
- Changes in net working capital
- Taxes
Irrelevant:
- Sunk costs
- Financing costs
What is Depreciation
Depreciation is the loss of value in an asset over time, often as a result of wear and tear
What are the 2 method of Depreciation
- Straight line
- Reducing balance
What is the Straight line method of depreciation
It spreads the asset’s costs evenly over its useful life
Annual Depreciation = (Initial cost - Salvage value) / Years of life
What is the Reducing balance method of depreciation
It applies a percentage reduction to the asset value each year, the value of depreciation reduces over time
What is the PROCEDURE for calculating incremental cash flows for investment decisions
- Revenues
- Costs/Expenses
- Depreciation
- Net Income
- Operating Cash Flow
- Total change in NWC
- Capital spending
- Net Cash Flow
- Investment Criteria
What other analyses can we use to evaluate NPV (x4)
- Base case estimation - NPV based on estimated cash flows
- Scenario analysis - consider a best case and worst case scenario and examine NPV for these cases
- Sensitivity analysis - consider changing only one input variable and examine how this affects NPV
- Stimulation analysis - vary lots of input variables simultaneously to construct a probability distribution for NPV across many scenarios
What is ‘paralysis by analysis’
When overthinking or excessive analysis delays decision making. A company must eventually act rather than endlessly evaluating options
