By Don Dayanada; et al
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Cash, inventories of raw materials and finished goods, and accounts receivable (customers’ unpaid bills) are examples of current assets. Current liabilities include accounts payable (the firm’s unpaid bills) and wages payable. When a new project starts, it may be necessary to increase the amount of cash held as a float to accommodate more transactions. Further inventories of raw materials may be required to run the new production lines smoothly. Additional investment in finished goods inventories may be necessary to handle increased sales.
37 38 Capital Budgeting Capital outlays of the project may be relatively easy to estimate. In many cases, they are made during the first year or the first few years of the project in its establishment stages. Sales and operating expenses normally occur throughout the planning period for the project analysis. From the sales and operating expenses, net operating cash flows can be derived. By adjusting these estimates for tax factors, the after-tax cash flows can be calculated. It is also important to identify all the variables that determine the cash flows and to assess which of those variables have the greatest influence on cash flows.
Project cash flows 13 marginal, or incremental, analysis comparing two situations. Erroneous comparisons such as ‘before versus after’ should be avoided. For example, suppose a new manufacturing plant uses land that could otherwise be sold for $500,000. The firm owns the land ‘before’ the project and the firm still owns the land ‘after’ the project. Therefore, if a ‘before versus after’ comparison is used, the cash flow attributed to the manufacturing project will be zero. However, the land is a valuable resource and it is not free.
Capital budgeting : financial appraisal of investment projects by Don Dayanada; et al