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Bus 401 Final Project

Caledonia should focus on cash flow statements which show how much cash a company receives and spends. Cash flow statements list only cash items and help shareholders understand how cash is generated and managed. Depreciation is a non-cash item, so it is added back when preparing cash flow statements. Sunk costs that have already been incurred on a project should be ignored when evaluating that project. The project has a positive NPV of $16,731,096 and an IRR of 77% based on a 15% cost of capital, indicating the project is feasible. Sensitivity analysis identifies how changes to inputs impact outputs to understand why a project could fail.

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86 views5 pages

Bus 401 Final Project

Caledonia should focus on cash flow statements which show how much cash a company receives and spends. Cash flow statements list only cash items and help shareholders understand how cash is generated and managed. Depreciation is a non-cash item, so it is added back when preparing cash flow statements. Sunk costs that have already been incurred on a project should be ignored when evaluating that project. The project has a positive NPV of $16,731,096 and an IRR of 77% based on a 15% cost of capital, indicating the project is feasible. Sensitivity analysis identifies how changes to inputs impact outputs to understand why a project could fail.

Uploaded by

Accounting Guy
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We take content rights seriously. If you suspect this is your content, claim it here.
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a. Caledonia should focus on cash flow statement.

The main objective of cash flow statement is to


disclose the information to the shareholder which is not present in balance sheet and income
statement. They show that how much company received and spend throughout the year. It lists all the
items of cash only. It helps shareholders to see that how much cash was actually generated by the
company and how well the cash was managed by the firm. A part from that we should focus on
incremental cash flow as they are the marginal benefits from the project and they increase value to
the firm once accepted.
b. Depreciation is non-cash items. When calculation accounting profit in income statement we simply
deduct it and as a result we get a low profit and hence low tax. But on the same time when we prepare
cash flow statement we add it back as it is not a cash item. If we see, we can notice that depreciation
never affects cash flow directly but it do effect it indirectly as the more depreciation the less will be
the net income and the less will be taxes. So it does affect taxes of the company and taxes are cash
items of the company.
c. Sunk cost is the expense that has already been expensed to a project. For example a research cost that
has been incurred before accepting a project will be treated as sunk cost. We only consider

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incremental after tax cash flow as the sunk is irrelevant for the project. So we completely ignore sunk
cost while accepting a project.

g. Diagram of cash flow:


1 2 3 4 5

$3,956,000 $8,416,000 $10,900,000 $8,548,000 $5,980,400

($8,100,000)

h. NPV is $16,731,096. (As calculated in excel)

i. IRR of the project is 77%. (As calculated in excel)

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j. Net present value is the amount that is calculated by discounting all inflows and outflows of cash by a chosen cost of capital of a
capital investment project. As we have already calculated the Net Present Value of this project which is $16,731,096 with 15%
cost of capital. This positive NPV shows that the project is feasible as when the Net Present Value is positive it is favorable to
accept.

k. Three measures of a project’s risk:


 Systematic Risk
 Total Project Risk
 Contribution to firm Risk

Systematic Risk:
Systematic risk is a risk that can never be diversified as it is present in that particular industry or investment. It varies from
industry to industry and investment to investment.
Total Project Risk:
The total project risk is the risk that is contributed by the project itself to the firm, but it is diversified when it combines with the
other projects or assets of the firm.

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Contribution to firm Risk:
The Contribution to firm Risk is the risk that is contributed by the project itself to the firm; this takes into account that risk is
diversified when it combines with the other projects or assets of the firm but it simply ignores the shareholders diversification
effect.
l. Systematic risk is applicable for capital budgeting process. Sometimes shareholders from undiversified background are there for
the firm and pertinent degree of risk is the project’s contribution to firm risk for those shareholders. Bankruptcy is influential in
systematic risk due to the cost associated with it.
m. Simulation basically allows us to stimulate the performance of a project for given variable. The simulation
model is done by assigning a range of random numbers to every possible value of each of the uncertain
variables. In response, the output from a simulation is a probability distribution of NPV or IRR for the
project. Then the decision is made on the basis of full range of possible outcomes.

n. sensitivity analysis is a technique which is used to identify that how different values of an independent variable will have an
impact on a particular dependent variable under a given set of assumptions. An assessment can be done by changing the value of one
input variable and keeping all other constant. Sensitivity analysis gives you an indication that why a project could fail.

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