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CFFM6_ch 12_slides - Chapter 12 Cash Flow Estimation and...

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Cash Flow Estimation and  Risk Analysis Chapter 12 Relevant Cash Flows Incorporating Inflation Types of Risk Risk Analysis 12-1
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Proposed Project Total depreciable cost Equipment: $200,000 Shipping and installation: $40,000 Changes in working capital Inventories will rise by $25,000 Accounts payable will rise by $5,000 Effect on operations New sales: 100,000 units/year @ $2/unit Variable cost: 60% of sales 12-2
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Proposed Project Life of the project Economic life: 4 years Depreciable life: MACRS 3-year class Salvage value: $25,000 Tax rate: 40% WACC: 10% 12-3
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Determining Project Value Estimate relevant cash flows Calculating annual operating cash flows. Identifying changes in working capital. Calculating terminal cash flows:  after-tax  salvage value and return of NWC. 12-4 0 1 2 3 4
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Initial Year Net Cash Flow Find  NWC.  in inventories of $25,000 Funded partly by an  in A/P of $5,000 NWC = $25,000 – $5,000 = $20,000 Combine  NWC with initial costs. Equipment         -$200,000 12-5
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Determining Annual Depreciation  Expense Year Rate   x  Basis Deprec.   1 0.33   x $240 $  79   2 0.45   x   240   108 12-6
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Annual Operating Cash Flows 1 2 3 4 Revenues 200.0 200.0 200.0 200.0 – Op. costs -120.0 -120.0 -120.0 -120.0 – Deprec. expense    -79.2 -108.0    -36.0    -16.8 Operating income (BT) 0.8 -28.0 44.0 63.2 – Tax (40%)       0.3    -11.2     17.6     25.3 Operating income (AT) 0.5 -16.8 26.4 37.9 + Deprec. expense        79.2   108.0     36.0     16.8 Operating CF 79.7 91.2 62.4 54.7 (Thousands of dollars) 12-7
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Terminal Cash Flow Q. How is NWC recovered? Q. Is there always a tax on SV? Q. Is the tax on SV ever a positive cash flow? 12-8 Recovery of NWC  $20,000  Salvage value  25,000  Tax of SV (40%)  -10,000   Terminal CF  $35,000  
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Should financing effects be included in  cash flows? No, dividends and interest expense should  not be included in the analysis.  Financing effects have already been taken  into account by discounting cash flows at the  WACC of 10%. Deducting interest expense and dividends  would be “double counting” financing costs. 12-9
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Should a $50,000 improvement cost from the  previous year be included in the analysis? No, the building improvement cost is a sunk  cost and should not be considered.
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