Cash Flow Estimation and Risk Analysis
1. Why are incremental cash flows the relevant cash flows for capital budgeting analysis? Why not just analyze the levels of cash flow and be done with it? Fully explain.
2. Should cannibalization effects be considered sunk costs or opportunity costs in a capital budgeting context? Explain.
3. What problem would arise if in projecting cash flows for a capital budgeting decision on a project interest expense was not excluded?
4. Why do firms typically choose to use MACRS depreciation methods to compute depreciation expense for tax purposes yet report depreciation expense to stockholders using straight line depreciation?
5. Carrying out NPV analysis using computer simulation methods tends to lead to a more ambiguous capital budgeting accept/reject situation than conventional NPV analysis (which concludes with either an "accept" or "reject" decision). Why then use simulation analysis if the technique clouds the accept/reject decision?
6. In a capital budgeting context what is an "embedded option"? Briefly explain how an embedded option can affect the value of a conventionally-calculated project NPV.