Introduction to Corporate Finance

PArT 3: CAPITAL BUDGETING

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

Under this scheme, small businesses were able

to deduct the full cost of any individual asset

purchased for less than $6,500 at the time they

purchased it, rather than depreciating the asset over

time. Thus the cash flow benefit (which reduces

taxable income) would have occurred immediately.

As we will see in this chapter, the timing of expenses

can have a major impact on cash flows, which in turn

have an impact on NPVs. (If the same positive cash

flow occurs in the future, its NPV will be less than if it

occurred today. Similarly, an expense incurred today

will provide a greater tax benefit than the same

expense incurred in the future, assuming tax rates

remain constant.)

Sources: Adapted from Press Releases by the Hon. Wayne Swan MP,

former Deputy Prime Minister and Treasurer: ‘Small Business and General

Business Tax Break’, 3 February 2009, http://www.treasurer.gov.au/

DisplayDocs.aspx?doc=pressreleases/2009/013.htm&pageID=003&m

in=wms&Year=&DocType=0; and ‘Tax relief for Australia’s 2.7 million

small businesses’, 5 July 2012, http://www.treasurer.gov.au/ DisplayDocs.

aspx?doc=pressreleases/2012/058.htm&pageID=003&min=wms&Year=&D

ocType=0. Accessed 9 December 2015.

differentiate between cash flow and

accounting profit with regard to

incremental cash flow, financing costs,

taxes and non-cash expenses

discuss depreciation, fixed asset

expenditures, working capital expenditures

and terminal value

understand relevant cash flows and the

effects of sunk costs, opportunity costs and

cannibalisation

demonstrate the procedures for

determining the relevant cash flows for a

capital budgeting problem

analyse capital rationing decisions,

competing replacement projects with

unequal lives and excess capacity

utilisation projects

describe how the human element can

affect the capital budgeting process and

its outcomes.

LO10.4

LO10.5

LO10.6

LO10.1

LO10.2

LO10.3

Chapter 9 described various capital budgeting

techniques that analysts use to evaluate and rank

investment proposals. Each of the examples in

Chapter 9 began with a sequence of cash flows,

although we did not discuss the origins of those

cash flow numbers. This chapter describes how to

determine the relevant cash flows. We begin with

an overview of the kinds of cash flows that may

appear in almost any type of investment. Next, we

present an extended capital budgeting example

and discuss special problems and situations that

frequently arise in the capital budgeting process.

The chapter concludes with a brief discussion of

the human element in capital budgeting.