Advanced Topics in Capital Investment Analysis

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SUBJECT: Financial Management 2
TOPIC: Chapter 9 - Advanced Topics in Capital Investment Analysis

INFLATION AND CAPITAL BUDGETING
Inflation – is the increase in the general level of prices for all goods and services in an economy. Inflation and Opportunity Cost of Capital
oRisk Premium - risky investments must provide an investor with the potential for larger returns to warrant the risks of the investment. oRisk-free Rate - is the minimum return expected by providers of capital compensation for inflation and waiting time Real Rate of Interest - An interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower, and the real yield to the lender. Expected Rate of Interest - It is the percentage rate of change in price level over time, usually one year. Inflation Adjustment for Cash Flows

Once the inflation rate has been defined, the opportunity cost of capital which fully reflects that factor would be applied to the estimates of future cash flows. Inflation, Depreciation and Taxes

Depreciation is one of the deductions from operating income in order to arrive at taxable income and taxes.

GOVERNMENT INCENTIVES AND CAPITAL BUDGETING
1)Pioneer Enterprise – those engaged in the commercial manufacture or processing of goods not previously produced locally. 2) Export producers or traders – the producers sells its products abroad while the traders should derive at least 20% of its gross income from exports. 3) Enterprises engaged in “preferred” areas – those producing import-substitutes or conducting further processing of agricultural, mining and forest products for export. 4) Service exporters and tourism enterprises – those engaged in professional services paid in foreign currency. The first type of tax incentives includes implicit tax holidays or exemption and tax credits. The second type involve special allowable deduction against taxable income; and Third type merely delays the...
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