Intro to finance 5

18 flashcards · Other · by Daniel F.

1. Incremental cash flow

   The difference between a firm's future cash flows with a project and those without the project Not only cash flows created by a new product/project, but also changes in cash flows of the existing products. NOT Sunk costs Opportunity costs Side effects Allocated costs NOT Financing cost

2. sunk cost

   A cost that has already been incurred and cannot be removed should NOT be considered in an investment decision e.g. cost of: repairing a machine to be used for a new project R&D spending to develop a new product searching for market potential

3. opportunity cost

   The most valuable alternative that is given up if a particular investment is undertaken should be considered in an investment decision e.g.: Assets that are already owned by a firm will be used for a proposed project

4. side effect (erosion)

   The cash flows of a new project that come at the expense of a firm's existing projects should be considered in an investment decision e.g.: Selling fewer hot dogs because hamburgers were added to the menu

5. Allocated costs

   change in NWC

6. Project Operating Cash Flow

   Operating cash flow = Net Income + Depreciation - Δ NWC Operating cash flow = tax shield approach EBIT * (1-T) + Depreciation * T - Δ NWC Cash flows belonging to a specific project. Interest expense and tax savings from it are not included

7. Project annual depreciation (straight line)

   Annual depreciation = (InitialCost+Installation)−ExpectedResidualValueEconomicLife\frac{(Initial Cost + Installation) - Expected Residual Value}{Economic Life}EconomicLife(InitialCost+Installation)−ExpectedResidualValue​ expected residual value /=/ end-of-life market value

8. How do I calculate Project Operating Cash Flow

   initial spending of capital expenditures and increase in NWC calculate project OCF for every year Dont use interests pay attention to add terminal year cost recuperation NWC recovery after tax salvage value

9. After tax salvage value

   MV + (BV - MV) * Tc market value + (book value - market value) * tax credit if I made profit selling the asset, I have to pay income tax if using straight line depreciation book value is 0 at the end of the economic life of the project

10. NWC recovery

    if there is only year 0 NWC change recovered NWC = NWC in year 0 otherwise not all of NWC is recovered, but only what is left

11. evaluating projects with different economic lifes

    Equivalent Annual Cost (EAC) annuitize (convert to annuity) the present value of the projects costs over the projects life use function PMT -> convert to equivalent annual cash outflows

12. cost of capital

    Debt financing (D cost: Rd) interest financial banks non-back lenders suppliers calculated cost bond holders Equity financing (E cost: Re) common stock holders retained earnings Hybrid equity financing (PS cost: Rps) preferred stockholders

13. What is weighted average cost of capital (WACC)

    minimum acceptable rate of return that firm should earn on its investments with average risk, in order to be profitable the return that investors require on the total assets of the firm includes the after-tax cost of the firms long-term debt discount rate for computing NPV hurdle rate: IRR > WACC

14. WACC formula

    Weight: percentage of each component in total capital V = E + D + PS 100% = (E/V)+(D/V)+(PS/V) market value preferred, book value can be used otherwise Cost of debt is calculated after tax (tax deductible)

15. Cost of debt Rd

    Interest rate (required return by instutions): financial banks, non-back lenders, suppliers YTM (Required rate by investors): bonds

16. cost of preferred stock Rps

    PSholders get contnt dividend with no maturity date Rps = Dp/Net price Dp = dividend to PSholders, Net price = net price per PS

17. cost of equity Re

    External: rate of return that investors demand or expect to make on money invested in a company's common stock CAPM if publicly traded Be is systematic risk, market risk dividend growth model Internal: Using retained earnings is internal financing but it still has a cost Opportunity Cost of investors not being able to invest the money OC = CAPM or DGM BUT company saves flotation costs

18. floatation cost

    10%, the cost to issue stocks as a publicly traded company, the cost involved for both equity and debt fA = (E/V) x fE + (D/V) x fD