Topic06_capbud2[1]

Topic06_capbud2[1] - Thomas Moeller FINA 30153: Financial...

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Unformatted text preview: Thomas Moeller FINA 30153: Financial Management 1 Topic 6 Capital Budgeting II Objectives 1. Project cash flows: basic tenets 2. Identify cash flows 3. Understand capital budgeting steps 4. Analyze investment projects 5. Analyze projects with different lives Thomas Moeller FINA 30153: Financial Management 2 1. Project cash flows: basic tenets 1. Discount expected cash flows, not accounting income: Revenues - operating costs - depreciation = taxable income - income tax = net income + depreciation ( and other non-cash expenses ) - capital expenses - increase in net working capital = net cash flow 2. Estimate incremental, after-tax cash flows Incr. CF = CF with project CF w/o project 3. Treat inflation consistently (1 + r nominal ) = (1 + r real ) (1 + inflation) 4. Do not include cash flows from financing (i.e., separate investment & financing decisions) Thomas Moeller FINA 30153: Financial Management 3 2. Identifying cash flows When you are estimating cash flows, you should consider the following factors: - Investment costs and outlays - Installation cost - Value of resources on hand (opportunity cost) Example: Suppose a firm plans to construct a building on land the firm already owns. Should the market value of the land be included in the cost of the project? - Ignore sunk costs (costs that the firm already incurred, but has no current or future value) Example: Suppose a firm already spent $50,000 on the architectural design of a new building. Should this expense be included in the cost of the project? Thomas Moeller FINA 30153: Financial Management 4- Net working capital changes a) Net working capital is the difference between current assets and current liabilities. b) An increase in net working capital is a cash outflow. c) A decrease in net working capital is a cash inflow. Example: A project increases cash, accounts receivable, and inventories by $100,000 more than accounts payables. Is this a cash inflow or outflow? - Incremental cash flows Example: Suppose a machine is generating positive cash flows of $50,000. If you buy another machine, the positive cash flows will increase to $125,000. What are the relevant cash flows to making the investment decision? decision?...
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Topic06_capbud2[1] - Thomas Moeller FINA 30153: Financial...

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