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Lecture 5: Making Capital Investment Decision (5.Cash Flow & Inflation…
Lecture 5: Making Capital Investment Decision
1.Sunk Cost
Definition
CF Already occured
Rule
Ignore all sunk cost
Opportunity Cost
Definition
Lost revenue you forego as a result of making proposed invesment
Rule
Incoparate OC into analysis
Side Effects
Definition
Erosion
New product reduce the CF of existing product
Synergy
New product improve the CF of existing products
Rule
Include Side Effect
Allocated Cost
Definition
Accounting measure to reflect expenditure or an assets use across the whole company
Rule
should be viewed as cash outflow only if it is an incremental cost of the project
5.Cash Flow & Inflation
Nominal Cash Flow
actual money in cash to be paid out or received
Real Cash Flow
purchasing power of cash once inflation has been taken into account.
Discounting
Nominal CF discount at nominal rate
Real CF discount at real rate
Formula
Real intrest rate = (1+Nominal Intrest rate / 1+ Inflation Rate) -1