Chapter 12: Cash Flows Estimation and Risk Analysis

1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow.

The relatively well posed project with promises of great future pay offs must be examined closely nevertheless to determine its true profitability. As such, the Super Project’s NPV must be calculated, however before we proceed we must acknowledge the relevant cash flows. The project incurred an expense of testing the market. This expense, however, must not be included in our cash flow analysis because it can be considered a sunk cost. This expense is required for ‘taking a temperature’ of the market and will not be recovered. Other sources of cash flow include:

This project will most likely involve debt financing. This means that interest expense would occur and should be taken into account in the analysis of the project. Interest expense is a cash expense and is automatically included when the net cash flows are

1. The first step to evaluating the cash flows is to conduct the depreciation tax flow analysis. Depreciation is not a cash flow, but the depreciation expense lows the taxes payable for the company. As a result, the tax effect of deprecation needs to be calculated as a cash flow. There are two depreciable items on the company's balance sheet the building and the equipment. The equipment is known to have a seven year depreciable life, which will be assumed to be straight line. The building is also assumed to be subject to straight line depreciation, this time of forty years. The tax saving reflects the depreciation expense multiplied by the tax rate, which in this case is assumed to be 28%. The following table illustrates the tax effect in future dollars of the depreciation expense:

1. Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project? C

We need to have sufficient information and right tools for cash flow forecast. Sometimes this cash flowing forecast are likely to be more accurate than other types of complex problem. For example a company started their business with £5,000 and their first month’s sale is £5,500, so their end of sales would be £66,000 and expenses would be £55,440 and their net cash flow is £10,503.

The incremental cash flows interest us because, looking at the project from the point of the company as a whole, the incremental cash flows are the marginal benefits from the project and, as such, are the increased value to the firm from accepting the project.

9. You are analyzing the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?

We are content with the 1.1 and the 0.9 project risk-adjustment factors because they use both of the minimal acceptable rate of return and associated risk. There is a

Capital budgeting is the process of assessing the profitability of future business projects, such as starting a new product or service line, in context of a business's resources and return requirements. This type of analysis is vital for small businesses, since choosing the right business opportunity (Cromwell, 2014). Under capital budgeting, you calculate the WACC for your business and the IRR for the project, and if the IRR is greater than the WACC, it is a profitable project you should pursue.

417). In other words, these are the cash flows that will only occur if we do accept the project.

6.The Year 0 net investment outlay for the project is $-475,000. This computed by adding the price of the machinery, installation, shipping, and the change in net working capital. The non-operating cash flow when the project is

a. Capital budgeting is the process of analyzing projects and determining which ones to accept and include in the capital budget.

The opportunity cost of renting the plant is included in the analysis as a after tax cost (cash outflow) because it will not be earned as a result of utilizing the asset for the project.

The following paper analyzes a project from financial perspectives using the capital budgeting techniques like Net Present Value (NPV) and Internal Rate of Return (IRR).