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CORPORATE FINANCE

Corporate Finance

SUMMARY: ch# 10 Making Capital Investment Decisions

Sir Usman Yousaf

Submitted To:
Madeeha Tariq L1F11MBAM0005 DATE: 18/10/11

Submitted By:

MAKING CAPITAL INVESTMENT DECISIONS

CORPORATE FINANCE

This chapter has described how to put together a discounted cash flow analysis, in it we covered. After reading this chapter we will understand that how to determine the relevant cash flows for a proposed project. hoe to determine if a project is acceptable. The major effect of taking a project is to increase the overall cash of the firm. The first step is to identify the relevant cash flows which add value in firm. The relevant cash flows are the defined in terms of changes in or increments to, the firm existing cash flows are known as incremental cash flows. any cash flow that exists regardless of whether or not a project is undertaken is not relevant. The assumption that evaluation of a project may be based on the projects incremental cash flows is the stand alone principal. A cost that has already been incurred and cannot be removed and there fore should not be considered in the investment decision opportunity cost is The most valuable alternative that is given up if a particular investment is undertaken. Remember that the incremental cash flows for a project include all the resulting changes in the firms future cash flows. It would not be unusual for a project to have side, or spillover affects both good and bad. in accounting for erosion ot is important to identify that the sales we forgone to launch a new product might be lost anyway in a future competition. The initial investment of firm is in the form of account t receivables and the inventories it can also be in the form of account payables which the firm has to supply this comes under the heading of working capital. Our goal in project evaluation is to compare the cash flows from a project to the cost of acquiring those projects to estimate the npv. Preparing and using pro forma, or projected, financial statements: we showed how information from such financial statements is

MAKING CAPITAL INVESTMENT DECISIONS

CORPORATE FINANCE

Useful in coming up with projected cash flows and we also look at some alternative definition of operating cash flow. Pro forma statement is very easily and convenient means of preparing and summarizing the much of the relevant information for a project. Cash flow from asset has three components: Operating cash flow, capital spending, and changes in net working capital. Project cash flow = project operating cash flow-project change in net working capital-project capital spending Operating cash flow= EBIT+depreciation-taxes The role of the net working capital and depreciation in determining project cash flows: we saw that including the change in net working capital was important in cash flow analysis because it adjusted for the discrepancy between accounting revenues and cost and cash revenues and costs. We also went over the calculation of depreciation expense under current tax law. Some special cases encountered in using the discounted cash flow analysis: here we looked at three special issues: evaluating cost cutting investments, how to go about setting a bid price and the unequal live problems. The way that depreciation is computed for tax is the relevant method for capital investment decisions.ACRS means a method under u.s tax law allowing for the accelerated write off of the property under various classifications. The MACRS is that every asset is assigned to a particular class. Every class establishes its life for tax.the depreciation can be calculated by multiplying the assets cost with the fixed percentage.

MAKING CAPITAL INVESTMENT DECISIONS

CORPORATE FINANCE

Year 1 2 3 4 5 6

MARCS % 20.00% 32.00% 19.20% 11.52% 11.52% 5.76%

DEPRICIATION .2000*$12000=$ 2,400,00 .3200*$12000=$3840.00 .1920*$12000=$2304.00 .1152*$12000=$1382.40 .1152*$12000=$1382.40 .0576*$12000=$ 691.20

100% $ 12000.00
The book value of an asset differs substantially from its actual market value. Remember that increase in net working capital is a cash outflow, so we use a negative sign in the table to show the additional investment that the firm make in working capital the positive sign represent the return of net working capital. There are different approaches of operating cash flow they all are giving the same results if they are used properly and accurately. When we say cash flow we literally mean that cash inflow is less then outflow. The use of many different ways of operating cash flows create sometimes a bit confusion to clear this it is explains clearly in this chapter. Different ways used to manipulate different information like cost, sales, depreciation, and taxes to get at cash flow. There are different approaches for it like bottom up approach, the top down and tax shield approach. These all approaches are same but many people dont rely on any one of these because in every problem there is an approach but people dont recognize that. at the end of this chapter there are three cases which involve discounted cash flows. These are evaluating cost cutting proposals, setting the bid price and evaluating equipments with different lives.

MAKING CAPITAL INVESTMENT DECISIONS