Fundamentals of Capital Budgeting - Forecasting Incremental Earnings

10 important questions on Fundamentals of Capital Budgeting - Forecasting Incremental Earnings

How are upfront investments such as market research, prototypes and ad campaigns for a new product accounted for?

Operating expenses in the year they occur

What is straight-line depreciation?

Linear depreciation of an investment over the entire life span of the good

Why would a company choose to depreciate the costs of investment instead of booking it off in one go?

To match the costs of the investment to the created earnings with the same period
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Why does capital budgeting focus on the incremental earnings instead of total?

Because when evaluating a project we are interested in the change it brings, not total outcome

Give the formula to calculate the Incremental EBIT

Incremental EBIT = Incremental Revenue - Incremental Costs - Depreciation

What is a marginal corporate tax rate?

The tax rate a firm has to pay over an incremental dollar of pre-tax income

How do you calculate the incremental income tax expense?

Incremental Income Tax = Incremental EBIT x Marginal Corporate Tax Rate

With what formula do you calculate Incremental Earning directly? (including tax rate)

Incremental Earnings = (Incremental Revenues - Incremental Cost - Depreciation) x (1-Tax Rate)
Which essentially is:
Incremental Earnings = EBIT x (1-Tax Rate)

What is a pro forma statement?

A statement that is based on assumptions rather than actual data

What is unlevered net income?

Net income that does not include interest expences associated with debt

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