Operating cash flows rather than accounting profits are listed in Table 12-1. Why do we focus on cash flows as opposed to net income in capital budgeting?
12-2 Explain why sunk costs should not be included in a capital budgeting analysis, but opportunity costs and externalities should be included. Give an example of each.
12-3 Explain why working capital is included in a capital budgeting analysis and how it is recovered at the end of a project’s life.
12-4 Why are interest charges not deducted when a project’s cash flows for use in a capital budgeting analysis are calculated?
12-5 Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, are our results biased, and if so, would the NPV be biased up or down? Explain.
12-6 What are some differences in the analysis for a replacement project versus that for a new expansion project?
12-7 Distinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in the capital budget.
12-8 In theory, market risk should be the only “relevant” risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on stand alone risk?
12-9 Define (a) sensitivity analysis, (b) scenario analysis, and (c) simulation analysis. If GE were considering two projects, one for $500 million to develop a satellite communications system and the other for $30,000 for a new truck, on which would the company be more likely to use a simulation analysis?
12-10 If you were the CFO of a company that had to decide on hundreds of potential projects every year, would you want to use sensitivity analysis and scenario analysis as described in the chapter, or would the amount of arithmetic required take too much time and thus not be cost effective? What involvement would nonfinancial people such as those in marketing, accounting, and production have in the analysis?
