Prof. Rushen Chahal
Cash Flows and Other Topicsin Capital Budgeting
Capital budgeting involves the decision-making process with respect to the investment infixed assets; specifically, it involves measuring the free cash flows or incremental cash flowsassociated with investment proposals and evaluating the attractiveness of these cash flowsrelative to the project's costs. This chapter focuses on the estimation of those cash flows basedon various decision criteria, and how to deal with capital rationing and mutually exclusive projects.
I.What criteria should we use in the evaluation of alternative investment proposals?A.Use free cash flows rather than accounting profits because free cash flowsallow us to correctly analyze the time element of the flows.B.Examine free cash flows on an after-tax basis because they are the flowsavailable to shareholders.C.Include only the incremental cash flows resulting from the investmentdecision. Ignore all other flows.D.In deciding which free cash flows are relevant we want to:1.Use free cash flows rather than accounting profits as our measurementtool.2.Think incrementally, looking at the company with and without the new project. Only incremental after tax cash flows, or free cash flows, arerelevant.3.Beware of cash flows diverted from existing products, again, looking atthe firm as a whole with the new product versus without the new product.