Chapter 11 mini case The questions A through N are as follows a. should Caledoni

Question

Chapter 11 mini case
The questions A through N are as follows

a. should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? should the compny be interested in incremental cash flows, incremental profits, total free cash flows, or total profits.
b.How does depriciation afect free cash flows?
c. How do sunk cost affect the determination of cash flows?
d. What is the projects initial outlay?
e. what are the differential cash flows over the project's life?
f. What is the terminal cash flow?
g. Draw a cash flow diagram for this project.
h. what is its new present Value
i. What is its internal rate of return?
j. should th project be accepted? why or why not?
k. In Capital budgeting, risk can be measured from three perspectives. What are those three measure of a projects risk
l. According to the CAPM, which measurment of risk is relevant what complictions does reality introdue into the capm vies of risk, and what does that mean for out view of the relevan measure of project risk?
m Explain how simulation works what is the value in using a simultion approach.
N. What is sensitivity analysis and what is its purpose?

Explanation / Answer

a. Caledonia should focus on cash flows rather than accounting profits because the firm can reinvest these cash flows. By examining cash flows, we are able to analyze the timing of either profits or cost. And we are only interested in cash flows on after-tax basis as those flows are available to the shareholder. In addition, it is the incremental cash flows that in which we are actually interested because incremental cash flows are benefits from the point of view of company and increase in value results in accepting the project.

b. Depreciation is considered non-cash flow item; it affects the differential cash flows over the life of the projects because it has effect on taxes. As depreciation is an expense, larger the expense, higher the depreciation. Hence accounting profits reduces and so taxes which are considered as an item of cash flow.

c. Sunk costs are ignored when evaluating capital budget. We are mainly interested in free cash flows for the company as whole. Irrespective of the decision on investment, the sunk costs have occurred which indicates that these are free cash flows. Hence, they are irrelevant.

d. Project

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