Answer to Question 1
FALSE
Answer to Question 2
In general, a project's free cash flows will fall into one of three categories: 1. the initial outlay, 2. the annual free cash
flows over the project's life, and 3 . the terminal free cash flow.
The initial outlay is the immediate cash outflow necessary to purchase the asset and put it in operating order. This
amount includes 1. the cost of purchasing the asset and getting it operational, including the purchase price, shipping
and installation, and any training costs for employees who will be operating the equipment, and 2. any increases in
working-capital requirements. If the investment decision is a replacement decision, the cash inflow associated with the
selling price of the old asset, in addition to any tax effects resulting from its sale, must be included. It should be
stressed that the incremental nature of the cash flow is of great importance. In many cases, if the project is not accepted,
then the status quo for the firm will simply not continue.
Annual free cash flows come from operating cash flows (that is, what you've made as a result of taking on the project),
changes in working capital, and any capital spending that might take place. In our calculations, we'll begin with our
pro forma statements and work from there. We will have to make adjustments for interest, depreciation, and working
capital, along with any capital expenditures that might occur.
The terminal cash flow is associated with the project's termination and includes the annual free cash flow and salvage
value of the project plus or minus any taxable gains or losses associated with its sale.
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