Caledonia Products
a) When making capital budgeting decisions, Caledonia should focus on cash flows rather than accounting profits. The argument in favor of cash flows is simple -- cash flows are what drive company value, more so than economic profit. Profit can be distorted by a number of considerations that do not impact on cash flows. For example, depreciation expense is not a cash flow, but a means of accounting for the fact that the up front purchase is not on the income statement. By using cash flows, it is easier to account for the time value of money because the cash flows are represented in the time period in which they occur -- that is not always the case with accounting for economic profit.
b) Depreciation is not included in the calculation of cash flows, because it is not a cash flow. The item that depreciation represents is the initial purchase. Depreciation, does however, have an impact on cash flows. Depreciation is an expense that lowers the EBITDA. This in turn results in a decreased tax obligation. Thus, the impact of depreciation on the cash flows is encapsulated in the "depreciation tax credit" of the net present value (NPV) calculation. This represents the after-tax cash benefit of the depreciation expense associated with the project.
c) Sunk costs are irrelevant to the cash flows. When making a capital budgeting decision, it is important to remember that any money already spent cannot be recouped no matter what decision is made. The money is gone. The decision about what to do in the future is not related to decisions that were made in the past; the decision only relates to cash flows that are directly impacted by the decision at hand.
d) The project's initial outlay is $8.1 million. This consists of three components. The largest of these is the initial purchase, which is $7.9 million for the equipment. Shipping and installation accounts for a further $100,000 of the initial outlay. Lastly, $100,000 in working capital is needed to get the project off the ground. This is also included in the initial outlay because it is needed now.
e) The differential cash flows over the project's life are $47.686 million in future value. These cash flows represent the sum total of cash flows associated with the investment decision, from the initial outlay to annual flows to the terminal cash flow.
f) The terminal cash flow is the flow at the end of the project. In this case, the termination of the project comes at the end of the fifth year. Given that all revenues and...
Caledonia focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project? After studying the Caledonia case I came to the conclusion that the reason that Caledonia should focus on free cash flows is because the cash flows are where the firm receives and is able to reinvest. Also the firm is only interested in the free cash
The discounted payback for each project is also in the fifth year, but further along in the fifth year for Project a compared to the simple payback. The net present value of Project a is $18,269. The net present value for Project B. is $18,690. The IRR for Project a is 18%, and the IRR for Project B. is 15%. (see Appendix B) The cause of the ranking conflict would be
This will also show the degree to which the project is vulnerable to potential changes on the market that would influence its main figures, including the volume of sales. Another useful tool that can be used is a simulation. A simulation would allows us, in this particular analysis, to change some of the variables in a mathematical model that we would create and analyze the consequences of those changes. The
Piper Alpha Disaster An Environmental and Safety Management Analysis of the Disaster that Occurred on the Piper Alpha Oil Rig off the Coast of Scotland Piper Alpha (Seconds from Disaster, 2013) The Incident The Piper before the Explosion Timeline of Events Piper Alpha Mechanism Root Causes of the Analysis Human Factors Design and Process Factor Financial Consequences Permit to Work System Safety Training Fire Walls Temporary Refuge Evacuation and Escape The Incident Piper Alpha was a North Sea oil production platform operated by Occidental Petroleum (Caledonia) Ltd.
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