1.the increase in inventory required due to new capital budgeting project implementation would be classified as a a. cost at time zero b. benefit at time zero c. cost in each year the firm needs the increased inventory d. benefit in each year the firm needs the increased inventory
I would think – this is part of the investment required for the project to start. So it would be a) Cost at time zero. CP
cpk123 Wrote: ------------------------------------------------------- > I would think – this is part of the investment > required for the project to start. So it would be > a) Cost at time zero. > > CP ---------------------------------------------------------- what if inventory is need later, not at time zero. but your answer is same as the Schweser one. I couldn’t it from CFAi book.
It is an investment to start the project and figures in as a cost at time 0. so it is the CF0 if you will consider it that. CP
cpk123 Wrote: ------------------------------------------------------- > It is an investment to start the project and > figures in as a cost at time 0. > > so it is the CF0 if you will consider it that. > > CP +++++++++++++++++++++++++++++++++++++++++++++++++++ under your rule, shall I discount those inventory cost to zero time when calculate CF0. I still the inventory cost is part of operating expense, should be subtracted when calculate later CF1, CF2…CFn. and there is a term" nonconventional cash flow" pattern.it is the initial outflow is not followed by inflows only, but the cash flows can flip from positive to negative again(even change signs several times). this mean later investment isn’t counted part of CF0, but counted itself . And this method discover the real timing of cashflow, and “true” NPV.
annexguy 1. This is an initial outflow. Very similar to how you would treat the cost of equipment you purchased under the new capital budgeting exercise, set up costs for the new plant , purchase of new land used to make the plant on, etc. etc. These would be a straight one time “removal” or “subtraction” from the current Cash flow – if you consider the company as a whole. These would be a part of -CF0 – for the new project if you look at it in isolation (without any interference from whatever the company is already doing). Does that make sense? This question is very similar to how you would treat the “startup” costs required for a firm that is getting into the business right this minute. and you were trying to evaluate the “viability” of the project using NPV, IRR or whatever other means you have. I believe you are getting yourself worked up over the Accrual Concept, Matching Principle and Capital budgeting exercise. CP
cpk is correct and provided a great explanation. This is also consistent with including the return of net working capital with the project’s terminal cash flow.
OK, I got it right now.
I have rather an naive question about this problem. Are cost and expense same ? An increase in inventory will cause cash outflow (and as explained by cpk will be a CFI). But the actual expense on income statement will be recognized only when goods are delievered as COGS. Am I thinking in correct direction ? Many thanks in advance !!
increase in inventory would be a cash outflow which would be a CFO outflow. Investment in Property, Plant and Equipment would be a CFI outflow. The Income statement is more an accounting practice, and translating how the money that came into the business is being utilized. The capital budgeting exercise is more of an exercise to see project viability, and as I said before, should not be confused with the Accrual concept and the matching principle. CP
Thanks CP ! I understand now…