Using Discounted Cash-Flow Analysis to Make investment Decisions - Indentifying Cash Flows - Discount Incremental Cash Flows

7 important questions on Using Discounted Cash-Flow Analysis to Make investment Decisions - Indentifying Cash Flows - Discount Incremental Cash Flows

What are the 6 examples of incremental cash flows to look out for?

1. Include all indirect effects
2. Forget sunk costs
3. Include opportunity costs
4. Recognize the investment in working capital
5.  Remember terminal cash flows
6. Beware of allocated overhead costs

What does include all indirect effects mean?

The decision to launch for example a new smartphone illustrates a common indirect effect. A new product often damages sales of an existing product. To forecast incremental cash flow, you must trace out all indirect effects of accepting the project.

What does forget sunk costs mean?

Sunk costs remain the samen whether or not you accept the project. Therefore, they do not affect project NPV.
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What does inlcude opportunity costs mean?

Resources are almost never free, even when no cash changes hands. For example, suppose a new manufacturing operation uses land that could otherwise be sold for $100.000. There is no out-of-pocket cost, but there is an opportunity cost. The opportunity cost equals the cash that could be realized from selling the land now: you lose that cash if you take the project.

What does recognize the investment in working capital mean?

Net working capital is the difference between a company’s short-term assets and its liabilities. Investments in working capital, just like investment in plant and equipment, result in cash outflows.
  • Short-term assets: accounts receivables, inventories of raw materials and finished goods.
  • Short-term liabilities: accounts payable, accruals (liabilities for items such as wages or taxes that have recently been incurred but have not yet been paid).

What does remember terminal cash flows means?

The end of a project almost always brings additional cash flows. For example, you might be able to sell some of the plant, equipment, or real estate that was dedicated to it. Also, you may recover some of your investment in working capital as you sell off inventories of finished goods and collect on outstanding accounts receivable.

What does beware of allocated overhead costs mean?

Like rent, hear or electricity. These overhead costs may not be related to a particular project, but they must be paid for, nevertheless.

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