free cash flows final

Initial Investment

The total upfront cash outlay required to start a project, occurring at $t=0$.

Fixed Assets

Long-term tangible assets like machinery, land, or buildings purchased to facilitate the project.

Net Working Capital

The additional investment in current assets (like inventory or accounts receivable) required to support a project, minus current liabilities.

Flotation Cost

The total cost incurred by a company in offering its securities (stocks or bonds) to the public, such as underwriting fees and legal expenses.

Net Cash Flows

The actual money a business makes over a period of time.

Relevant vs. Irrelevant cash flows

The distinction between cash flows that should be included in a capital budgeting analysis and those that should be ignored.

Incremental Cash Flow (relevant)

The specific change in a firm's total cash flow that occurs as a direct result of accepting a project.

Sunk Cost (excluded)

An outlay that has already occurred or been committed and cannot be recovered regardless of whether the project is accepted (e.g., a past marketing study).

Opportunity Cost (separate project)

The return that could be earned from the next best alternative use of an asset already owned by the company.

Externality (side effect)

The impact a new project has on the cash flows of other parts of the firm.

Positive Externalities

A 'synergy' where a new project increases the sales of existing products.

Negative Externalities

A situation where a new project reduces the cash flows of other existing projects.

Cannibalization

A specific type of negative externality where a new product takes sales away from the firm's own existing products.

Terminal Cash Flows

The final cash flows occurring at the end of a project's life when assets are liquidated.

Salvage Value

The estimated resale value of an asset at the end of its useful life, adjusted for taxes (After-tax Salvage Value).

Selling within the company

Transferring an asset to another department; it must still be valued at its fair market opportunity cost.

Not double counting

Ensuring that costs already accounted for in initial or operating stages (like depreciation) are not incorrectly subtracted again at the end.

Clean-up Cost

Any terminal expenses related to decommissioning an asset or environmental remediation.

Pro Forma Financial Statements

Financial statements based on projected or 'what-if' scenarios rather than actual historical data.

Forecasting

The process of predicting future financial performance (Sales, COGS, Taxes) to build the Pro Forma models.

Accrual vs. Cash Accounting

While accrual accounting (Net Income) records revenue when earned, capital budgeting relies on Cash Accounting, which records money only when it actually enters or leaves the bank.

Free cash flow Definition

The cash actually available for distribution to all investors (debt and equity) after the company has made all necessary investments in fixed assets and working capital.

Annual Forecasts

The year-by-year estimation of FCF over the life of the project used to calculate NPV.

Robustness

The degree to which a project remains profitable under varying conditions and assumptions.

Scenario analysis

A technique that calculates the NPV of a project under different sets of assumptions (e.g., 'Best Case,' 'Base Case,' and 'Worst Case').

Sensitivity analysis

A risk analysis tool that changes one variable at a time (like unit sales or cost of capital) to see how sensitive the NPV is to that specific change.

Monte Carlo Simulation

A computerized mathematical technique that runs thousands of trials using a range of possible values for any uncertain variable to see the probability distribution of potential outcomes.