Please enable JavaScript.
Coggle requires JavaScript to display documents.
Capital Budgeting and Cash Flows, image, image, image, CashFlow - Coggle…
Capital Budgeting and Cash Flows
investment can use two methods to
NPV
positive NPV means that the investment shareholders expectations and that thE firm should invest in the project
negative NPV this is known
as the borrowing versus lending problem
plot a graph called an NPV profile which shows the net present value of each investment at various
discount rates the profile of project
IRR
IRR method calculates the discount rate at which a project's NPV equals zero ifthe IRR exceeds the project's hurdle
the IRR can be difficult to interpret when a projects cash flow pattern is unusual
loan the firm should invest if the IRR
is greater than the hurdle rate
a project is analogous the firm should invest only when the IRR is less than the hurdle rate
rate to use in the NPV calculation should be the same as the hurdle rate to which the project's IRR is compared that rate represents the minimum acceptable
Depreciation and Cash Flow Adjustments
Depreciation is a non-cash expense and is added back to after-tax income to determine cash flow.
Opportunity Cost: In both years, an opportunity cost of $225,000 is deducted, representing the potential income lost by choosing this project over an alternative.
The final cash flow after accounting for opportunity cost is $580,600 in Year 1 and $610,360 in Year 2. These figures reflect the net cash generated by the project and are crucial in determining the project’s financial viability.
By analyzing the cash flows with tax effects, non-cash adjustments, and opportunity costs, this analysis provides a holistic view of the project's financial impact.
The final cash flow after accounting for opportunity cost is $580,600 in Year 1 and $610,360 in Year 2. These figures reflect the net cash generated by the project and are crucial in determining the project’s financial viability.
Fixed at $1,080,000 for both years, reflecting the cost of providing services or products directly associated with the revenue.
The chapter emphasizes the importance of calculating free cash flow, which represents the actual cash generated by a project after accounting for operating expenses and investments in capital.
Problems with IRR
Ranking competing problems, which lead to timing problems and scale problems
Scale problems refers to the issue where projects of different sizes (i.e., different scales of investment) are compared using the IRR metric, which can lead to misleading conclusions.
occurs when the timing of cash flows affects the comparison between projects, potentially leading to misleading conclusions. This issue arises because IRR assumes a constant reinvestment rate and focuses on percentage returns rather than the actual timing and magnitude of cash flows.
