Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, are our results biased? If so, would the NPV be biased up or down? Explain.
Step 11 of 2
Estimating cash flows on a daily basis is not usually done since the cost of estimating cash flows on such basis will exceed its benefits. The results will definitely not reflect its true or most accurate or theoretical value as compared to daily cash flows, but it will not be significantly different (as long as the cash flows are not abnormally spread during the period). Thus, there should not be any bias in the results.
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Woody Lightyear is considering the purchase of a toy store from Andy Enterprises. Woody expects the store will generate net cash flows (cash inflows less cash outflows) of $60,000 per year for 20 years. At the end of the 20 years, he intends to sell the store for$600,000. To finance the purchase, Woody will borrow using a 20-year note that requires 9% interest. What is the maximum amount Woody should offer Andy for the toy store? (Assume all cash flows occur at the end of each year.)