I know that it is probably tough to get back into school mode, but I hope that you are making the transition. In today’s class, we started by first revisiting the hurdle rate for the Rio Disney theme park, separating those risks that we should be bringing into it from those that we should not. We then started the move from earnings to cash flows, by making three standard adjustments: add back depreciation & amortization (which leaves the tax benefit of the depreciation in the cash flows), subtract out cap ex and subtract out changes in working capital. Finally, we introduced the key test for incremental cash flows by asking two questions: (1) What will happen if you take the project and (2) What will happen if you do not? If the answer is the same to both questions, the item is not incremental. That is why “sunk” costs, i.e., money already spent, should not affect investment decision making. It is also the reason that we add back the portion of allocated G&A that is fixed and thus has nothing to do with this project. I have attached the post class test for today, with the solution. In the final part of the class, we looked at time weighting cash flows, why and how we do it.
Post Class Test: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session12test.pdf
Post Class Test Solution: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session12soln.pdf