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Key Considerations in Capital Budgeting: Cash Flow Analysis and Replacement Decisions

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This guide provides essential insights into capital budgeting, focusing on cash flow analysis. It emphasizes the importance of estimating incremental after-tax cash flows, maintaining consistent treatment of inflation, and recognizing project interactions. Additionally, it delves into the differentiation between new and replacement projects, outlining initial outlay components, cash flows, and terminal cash flow calculations. Understanding these elements is crucial for making informed financial decisions in capital investments.

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Key Considerations in Capital Budgeting: Cash Flow Analysis and Replacement Decisions

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  1. WHAT TO DISCOUNT 1. Only cash flow is relevant. 2. Estimate incremental(after tax) cash flow. 3. Be consistent in treatment of inflation. 4. Recognize project interactions.

  2. Capital Budgeting: New vs Replacement 1. INITIAL OUTLAY 2. CASH FLOWS 3. TERMINAL CASH FLOW 1. INITIAL OUTLAY: a) Purchase price of M/C +Installation Cost +Trans. Cost… b) Sales of old M/C c) Working Capital 2. Cash Flows: a) Add back depreciation b) Do not include interest costs c) Working capital changes 3. Terminal Cash Flow: a) Salvage Value of New M/C tax effect b) Working Capital

  3. T9-4 Annual Cash Flows (In Thousands)

  4. T9-8 Inflation Effects

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