Finance Chapter 7 study Notes- Jerry Wu

In the world of Financing we ALWAYS discount cash flows, NOT earnings, when performing a capital budgeting calculation.
Sunk Cost- Cost that has already occurred and cannot be changed by the decision to accept or reject the project. eg, cost associated with paying a consulting firm to evaluate a project (SUNK COST)
Opportunity cost- The lost revenues the firm could have obtained by taking on a project

Side Effects- Two types
Erosion -When a new product reduces the sales and the cash flows of existing products
Synergy- When a new project increases the cash flows of existing projects.

Allocated Costs- A particular spending that benefits a number of projects. For capital budgeting purposes, it should only be viewed as a cash outflow of a project only if it is an incremental cost of the project.
Net Working Capital- The difference between current assets and current liabilities.
Real Interest Rate= (1+ Nominal interest rate)/ (1+Inflation rate) - 1
Real Interest Rate~ (approximation) = Nominal Interest Rate- Inflation Rate

Nominal cash flow-refers to the actual dollar received (or paid out)
Real Cash flow- The purchasing power of the cash flow. (Discounted with the inflation rate from the nominal cash flow).
Stand Alone Principle
Equivalent Annual Cost
Cash Flow and Depreciation
** Real interest Rate= (1+ Nominal Interest Rate/1+ Inflation Rate) -1**

Real vs Nominial Discounting: pg 209 ex 7.9, pg 210, ex 7.10
The NPV is the same whether cash flows are expressed in Nominal or in Real quantities, it must always be the case that the NPV is the same under the two different approaches. Therefore we should use the simpler approach to avoid computational errors"

To Be Continued…..

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