Making Capital Investment Decisions and Project Analysis and Evaluation

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Making Capital Investment Decisions and Project
Analysis and Evaluation
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Projecting Cash Flows
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What Cash Flows (CFt ) are Relevant?

• Only those cash flows that occur with the project
  but not without the project are relevant, i.e.,
  only incremental cash flows are relevant.
• Sunk Costs?
• Opportunity Costs?
• Externalities, e.g., erosion

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Projecting Cash Flows

• Projecting Cash Flows
• Pro Forma Operating Cash Flow (Cash Flow from
  Operations)
• Pro Forma Changes in Net Working Capital (Cash
  Flow from Operations)
• Pro Forma Changes in Fixed Assets (Cash Flow from
  Investment)
• Question Why arent cash flows from financing
  part of the cash flow projections?

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How are Cash Flows Defined?

• Total Cash Flows OCF - ? NWC -? Fixed Assets
• OCF
• Bottom Up
• Net Income Depreciation
• Top-Down
• Sales - Costs - Taxes
• Tax Shield
• (Sales-Costs)(1-T) TDepreciation

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Forecasting Risk What Can Go Wrong?

• Sales pq
• price per unit soldquantity sold
• Variable Costs vq
• variable cost per unitquantity
• Fixed Costs FC
• create operating leverage
• Costs of New Equipment, Salvage Value, and NWC
  requirements are all subject to estimation error.

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Ways of Dealing With Forecasting Error

• Scenario Analysis - the determination of what
  happens to NPV when we ask what-if questions
• Sensitivity Analysis - the determination of what
  happens to NPV when we change only one variable
  at a time.
• Simulation Analysis - the determination of a
  distribution of NPVs that depends on the
  distribution of outcomes for individual variables
  that are inputs for the NPV calculation.

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Problems 25 through 28 (Base Case)
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Problems 25 through 28 (Worst Case)
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Problems 25 through 28 (Best Case)