Fundamentals of Corporate Finance

10

Cash Flows and Capital Budgeting

Learning Objectives

Explain why incremental after-tax free cash flows are relevant in evaluating a project and calculate them for a project.

Discuss the five general rules for incremental after-tax free cash flow calculations and explain why cash flows stated in nominal (real) dollars should be discounted using a nominal (real) discount rate.

Describe how distinguishing between variable and fixed costs can be useful in forecasting operating expenses.

Explain the concept of equivalent annual cost and use it to compare projects with unequal lives.

On September 27, 2010, Southwest Airlines announced that it had agreed to purchase its smaller rival AirTran Airways for $1.4 billion in cash and stock. This would be the third large U.S. airline merger in two years. By the end of the day, Southwest's stock price was up 8.7 percent while the S&P 500 stock market index was down 0.5 percent. The 8.7 percent change in Southwest's stock price represented ...