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Cash Flow Estimation and Risk Analysis Paper

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NOTE 12: CASH FLOW ESTIMATION AND RISK ANALYSIS o Project Cash Flows o Incremental Cash Flows o Pro Forma Financial Statements and Project Cash Flows o Evaluating NPV Estimates o Scenario Analysis and Sensitivity Analysis o Additional Considerations in Capital Budgeting I. Fundamental Principles of Project Evaluation • Project evaluation - the application of one or more capital budgeting decision rules to estimated relevant project cash flows in order to make the investment decision. • Relevant cash flows - the incremental cash flows associated with the decision to invest in a project. The incremental cash flows for project evaluation consist of any and all changes in the firm’s future cash flows that are a direct consequence of taking the project. • Stand-alone principle - evaluation of a project based on the project’s incremental cash flows. II. Incremental Cash Flows • A. Terminology Sunk costs A cost that has already been incurred and cannot be recouped. Therefore, it should not be considered in an investment decision. B. Opportunity costs The most valuable alternative that is given up if a particular investment is undertaken. C. Side effects Erosion (Canniballization)– CF from a new project that come at the expense of a firm’s existing project. D. Net working capital The difference between CA and CL. E. Financing costs Dividend and interest. 1 III. Pro Forma Financial Statements and Project Cash Flows Example 1: Prepare a set ...
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