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Capital Budgeting and Cash Flows

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Why is capital budgeting such an important process? Why are capital budgeting errors so costly? Differentiate between NPV, PI, and IRR methods. What are the advantages and disadvantages of using each of these methods? Why is there a focus on cash flows rather than accounting profits in making capital-budgeting decisions? Why such an interest in incremental cash flows rather than total cash flows?

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Capital is such an important process because it helps the company decide how to allocate its limited resources in such a way that it the company will receive the highest value from the deployment of its resources. This is the reason why capital budgeting errors are so costly. Once the company decides on which capital project to finance and once the capital assets for the project are purchased, and if that ...

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Capital budgeting

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Capital Budgeting: PROPER CASH FLOWS, INCREMENTAL CASH FLOWS

1) PROPER CASH FLOWS: Quick computing currently sells 10 million computer chips each year at a price of $20 per chip. It is about to introduce a new chip, and it forcasts annual sales of 12 million of these improved chips at a price of $25 each. However, demand for the old chip will decrease and sales of the old chip are expected to fall to 3 million per year. The old chip costs $6 each tomanufacture and the new ones will costs $8 each. What is the proper cash flow to use to evaluate the present value of the introduction of the new chip?

2) INCREMENTAL CASH FLOWS: A corporation donates a valuable painting from its private collection to an art museum. Which of the following are incremental cash flows associated with the donation?

a. The price the firm paid for the painting.
b. The current market value of the painting.
c. The deduction from income tax that it declares for its charitable gift.
d. The reduction in taxes due to its declared tax deduction.

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