Fundamentals of capital budgeting PDF

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Fundamentals of capital budgeting...

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Fundamentals of capital budgeting Capital budgeting: evaluating NPV of multiple projects to create the capital budget (projects and investments a company plans to undertake) Incremental earnings: amount by which earnings are going to change as a result of investment decision → forecasting cash flows Straight-line depreciation: asset costs / estimated useful life Unlevered net income: does not include any interest expenses associated with debt Marginal corporate tax rate: tax rate it will pay on an incremental dollar of pre-tax income Income tax = EBIT (revenues-costs-depreciation) x t Unlevered net income = ebit x (1-t) Opportunity cost: value it could have provided in its best alternative use Project externalities: indirect effects of the project, increasing/decreasing other projects → cannibalization Sunk cost: any unrecoverable cost ‘if our decision does not affect the cash flow, then the cash flow should not affect our decision’ Fixed overhead expenses: expenses allocated to different business activities Past R&D expenditures: any money already spent is a sunk cost Free cash flow: effect of a project on cash → depreciation does not affect cash Net Working Capital = Cash + Inventory + Receivables - Payables Trade credit = receivables - payables (net amount capital that is consumed) Free cash flow = Unlevered net income + depreciation - capex - dNWC (increase in net working capital) = (revenues - costs ) x (1-t) - CapEx - dNWC + depreciation tax shield (t x depreciation) → tax savings that result from the ability to deduct depreciation PV(FreeCashFlow) = FCF / (1+r(cost of capital))^t Choosing between alternatives: only see the difference net working capital requirements Other Non-Cash Items: only include actual cash revenues/expenses Timing of cash flows: they are actually spread throughout the year MACRS depreciation: categorizing assets according to their recovery period Liquidation/salvage value: costs or profit of disposing used equipment Gain on sale = sale price - book value (purchase price - accumulated depreciation) After-Tax Cash Flow from Asset Sale=Sale Price - (t x gain on sale) Terminal/continuation value: estimating remaining free cash flow beyond forecast horizon Tax Loss Carryforwards (20years) and Carrybacks (2years): reducing present value of tax liability Break-even level of input → when investment has an NPV of zero (IRR) Sensitivity analysis: explores effects of errors in our NPV estimates Scenario analysis: considers the effect on NPV of changing multiple project parameters...