
Sunk costs
what a firm has already paid, is an expense they cannot get back.

Complementary vs substitutionary effects
comp increases while substitute decreases

Free Cash Flow (FCF)
operating cash flow (OCF)  investment in operating capital (IOC)

OCF
EBIT taxes + depreciation

financing fees/ costs
interest paid to debt holders or dividends paid to stock holders
are never included as incremental project cash flows

Incremental cash flows
cash flows attributed to a new project

depreciable basis
an assets cost plus the amounts you paid for an item such as sales tax, freight charges, and installation fees

after tax cash flow (ATCF)
 used when the sale of assets for more than depreciated book value as taxable gains and any sale less than for taxable losses.
 ATCF= book value + (mvbv) x (1 tax rate)

computing PV of tax benefits
 1) dep = end bv  beg bv / life of asset
 2) depreciation per year x tax rate
 3) 28,900 x (1(1/.13^10)) / (.13)

Computing Net PV
 take values and divide by 1 + rate raised to the year.
 1200 / (1.08)^1 = 111.11
 add them all up and subtract from the beginning cost 2985 2000 = 985 profit

Section 179 deductions
deduction targeted at small businesses that allows them to immediately expense asset purchases up to a certain limit rather than depreciating them over the assets useful lives.

Property eligible for a section 179 deduction
 machinery and equipment
 furniture
 most storage facilites

ineligible property for section 179 deduction
 buildings and their structural components
 property of an estate or fund
 property outside us

EAC (equivalent annual cost)
perpetuity account

estimating project cash flows requires us to consider
 cost and revenue
 the impact on existing products
 to use existing assets
 to include certain charger

depreciable basis for real property calculated as
cost+sales tax + freight charges + installation and testing

accelerated depreciation
more of the depreciation expense is earlier in the assets life, lowering taxes and increasing cash flow

Modified Accelerated Cost Recovery System
 MACRS
 incorporates the halfyear convention
 uses the doubledeclining balance depreciation method
the ultimate accelerated dep would be to expense immediately

Differing asset life
if we decide to go ahead with a new project but we have to choose between two alternatives, each with a different life, we use EAC method

Net Present Value
is the most common preferred technique for most project evaluations
represents the purest of the capital budgeting rules
measures the amount of value created by the project
completely consistent to maximize firm value

Three factors drive the choice of which decision rule to make
 the desired format?
 normal or nonnormal cash flows?
 independently or mutually exclusive project?

Three types of measurement units for financial decisions
 currency
 rate of return
 time

processing capital budgeting decisions
 identify how to calculate decision statistic
 decide on appropriate benchmark
 define what relationship btwn statistic and the benchmark will dictate

NPV strengths and weaknesses
strengths: no/go decision, not a ratio, works well with independent and mutually exclusive projects ( want to accept the project with the highest positive NPV )
Weakness: managers who are unfamiliar can misinterpret results

Payback: how long will it take to recoup costs
 has intuitive appeal
 remains popular because easy to compute
 built in assumptions

Discounted payback
ignores the time value of money

internal rate of return (IRR)
most popular technique to analyze projects
is generally consistent with NPV (problems with non normal cash flows and mutually exclusive projects)

