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McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Incremental Cash Flows
Sunk costs are not relevant
Just because “we have come this far” does not mean that we should continue to throw good money after bad.
Equivalent Annual Cost Method
McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
8.1 Incremental Cash Flows
Cash flows matter—not accounting earnings. Sunk costs don’t matter. Incremental cash flows matter. Opportunity costs matter. Side effects like cannibalism and erosion matter. Taxes matter: we want incremental after-tax
cash flows. Inflation matters.
McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Cash Flows—Not Accounting
Consider depreciation expense.
Opportunity costs do matter. Just because a
project has a positive NPV, that does not mean
that it should also have automatic acceptance.
Specifically, if another project with a higher NPV
If, however, synergies result that create increased demand of existing products, we also need to recognize that.
McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Side effects cannibalism are both bad things. If our new product causes existing customers to demand less of current products, we need to recognize that.
You never write a check made out to “depreciation.”
Much of the work in evaluating a project lies in taking accounting numbers and generating cash flows.
Estimating Cash Flows
Cash Flow from Operations
Recall that: OCF = EBIT – Taxes + Depreciation
Incorporate inflation into capital budgeting Understand the various methods for computing
operating cash flow Apply the Equivalent Annual Cost approach
would have to be passed up, then we should not
proceed.
McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Incremental Cash Flows
Chapter 8
Making Capital Investment Decisions
McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Key Concepts and Skills
McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
8.1 Incremental Cash Flows 8.2 The Baldwin Company: An Example 8.3 Inflation and Capital Budgeting 8.4 Alternative Definitions of Cash Flow 8.5 Investments of Unequal Lives: The
Understand how to determine the relevant cash flows for various types of capital investments
Be able to compute depreciation expense for tax purposes
