1. Concepts used in cash flow estimation Aa Aa Capital budgeting analysis not only requires the evaluation of cash flows but also requires the understanding of the origin of those cash flows. Based on your understanding of cash flows in a company, complete and answer the following questions: The present value of can be used to determine the basis of a company's value. Ideally, capital budgeting analysis should take cash flows into account Understanding the nature of projects Capital budgeting analysis often involves decisions related to expansion projects and/or replacement projects. Based on your understanding of expansion and replacement projects, complete the following A rental car company bought a new fleet of midsize cars and sold off its old midsize cars because they had too many miles on them. Which type of project would this be considered? A replacement project O An expansion project What are sunk costs? Marston Manufacturing Co. owns a warehouse that it is not currently using. It could sell the warehouse for $300,000 or use the warehouse in a new project. Should Marston Manufacturing Co. include the value of the warehouse as part of the initial investment in the new project or treat the value of the warehouse as a sunk cost? O No, treat the value of the warehouse as a sunk cost O Yes, include the value of the warehouse as part of the initial investment in the new project CanParts Pty Ltd and AmeriParts Pty Ltd are both auto parts manufacturers. Their revenues and expenses are identical except that AmeriParts claims a depreciation expense on its depreciable assets. Assuming all sales and expenses are for cash, which company will have the lower earnings before tax but the higher after-tax cash flow? 2. Identifying incremental cash flows Aa Aa When companies make capital budgeting decisions, they should concern themselves with incremental cash flows, not net income, when evaluating projects To determine the incremental cash flows from a project, an analyst should include all of the following except O Fixed-asset expenditures O Changes in net working capital O Financing costs O Depreciation Indirect cash flows often affect a company's capital budgeting decisions. However, some of these indirect cash flows are relevant to capital budgeting decisions (because they represent marginal cash flows that depend on the project's acceptance), but others should be ignored are costs the company paid in the past and are unrecoverable. Accepting or rejecting a project will not change them, so they should not be included in capital budgeting analysis Consider the case of Bumbly Products Ltd. The company is evaluating a capital budgeting project and has come across a few issues that require special attention. Classify each item as a sunk cost, cannibalisation, opportunity cost, or a change in net working capital (NWC). Then, in the last column, indicate whether the item should be included in the project's analysis or not. Change Sunk opportunity Cost Include in Cannibalisation in NWC the Analysis? Cost The new project is likely to have a negative impact on the company's existing related products The project will use some raw materials that the company has in its inventory and can sell at a certain price Bumbly invested in research and development to come up with this new product. Most of the purchases for this project will be made using cash, causing cash in the company to decrease O Most of the purchases for this project will be made using cash, causing cash in the company to decrease. The project will use some equipment that the company owns but isn't using currently. However, a used-equipment dealer has offered to buy the equipment Imagine Bumbly will be issuing debt to support this project and other capital budgeting projects this year. The company's interest expense will increase by $700,000. Should the change in interest expense be included in the analysis? O Yes No