Chapter 9: Making Capital Investment Decisions

Flashcards from Chapter 10 lecture notes, covering capital investment decisions, relevant cash flows, and project evaluation.

What is a relevant cash flow for a project?

A change in the firm’s overall future cash flow that comes about as a direct consequence of the decision to take that project.

What are incremental cash flows?

The difference between a firm’s future cash flows with a project and those without the project.

What is the stand-alone principle?

The assumption that evaluation of a project may be based on the project’s incremental cash flows.

What is a sunk cost?

A cost that has already been incurred and cannot be removed, therefore should not be considered in an investment decision.

What is opportunity cost?

The most valuable alternative that is given up if a particular investment is undertaken.

What is erosion in the context of project cash flows?

Occurs when the cash flows of a new project come at the expense of a firm’s existing projects.

How do you calculate operating cash flow?

Earnings before interest and taxes + Depreciation - Taxes

How is project cash flow calculated?

Project operating cash flow - Project change in net working capital - Project capital spending.

What is the average accounting return (AAR)?

Average net income divided by average book value.

What is the Accelerated Cost Recovery System (ACRS)?

A depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.

What is Modified ACRS depreciation (MACRS)?

Characterized by every asset being assigned to a particular class for depreciation purposes.

What is the bottom-up approach to calculating operating cash flow?

Net income + Depreciation

What is the top-down approach to calculating operating cash flow?

Sales - Costs - Taxes

What is the tax shield approach to calculating operating cash flow?

(Sales - Costs) * (1 - TC) + (Depreciation * TC)

What is equivalent annual cost (EAC)?

The PV of a project’s costs calculated on an annual basis.