Chapter 11 Cash Flows and Other Topics in Capital Budgeting

1) Accounting profits are used to make capital budgeting decisions because generally accepted accounting principles ensure that profits are the best measure of a company's economic activity.

2) Capital budgeting decisions are based on free cash flow because free cash flow better reflects when money is received and available for reinvestment than account profits.

3) The guiding rule in deciding if a free cash flow is incremental is to look at the company with, versus without, the new project.

4) A grocery store decides to offer beer for sale and this decision results in more potato chip sales. This is an example of a synergistic effect.

5) Additional investment in working capital, even if it may be recovered at the end of a project, must be included in capital budgeting analysis because of the time value of money.

6) Sunk costs are cash outflows that will occur regardless of the current accept/reject decision, and therefore should be excluded from the analysis.

7) Overhead costs are sometimes incremental cash flows and other times are considered sunk costs.

8) Interest payments on a loan obtained specifically to fund a new project should be considered an incremental cash flow for the new project when determining the accept/reject decision.

9) To be included in a capital budgeting analysis, all incremental free cash flows must be expensed on the company's books, otherwise generally accepted accounting principles will be violated.

10) In measuring cash flows we are interested only in the incremental or incremental after-tax cash flows that are attributed to the investment proposal being evaluated.