2018 January 10

January 10, 2018
Corporate Finance and Valuation
Corporate Finance and Valuation
“Case Study in Capital Budgeting”
Author: Anastasia Mantzarea
Student ID: 3217388
Msc in Finance

Case Study in Capital Budgeting
1). Define the term “incremental cash flow”. Since the project will be financed in part by debt, should the cash flow analysis include the interest expense? Explain.
Incremental cash flow analysis is used to review a change in the cash inflows and outflows that are specifically attributed to a management decision. In our case study, this decision refers to the evaluation of the new investment, importing in the market the new tomato lite juice. This term takes into account that there is no need to consider the aggregate cash flows associated with all operations of the company when evaluating an upcoming project.

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The analysis may be based on a variety of cash flows, such as the initial outlay of cash, ongoing inflows and outflows related to the maintenance, operations, and net receipts from the project, and any cash flows associated with the eventual termination of the project (which includes both cash inflows from sale of the equipment and cash outflows for remediation costs).

Interest expenses should not be included as costs in the cash flow analysis. In other words, they are not to be deducted from revenues when determining  Profit before tax, as normal accounting rules stipulate. To do this would be double counting, as interest expense (cost of debt) is already accounted for in the cost of capital, which is used to discount the cash flows.

2). Suppose another juice producer had expressed an interest in leasing the production site for $25,000 a year. If this true, how would this information be incorporated into the analysis?