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Ch8supp

# Ch8supp - Introduction CH.8 Supplementary note CCA...

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Introduction CH.8 Supplementary note: CCA calculation JHT Kim October 23, 2009 1/16

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Introduction Measuring CF on an incremental basis Depreciation Motivation To evaluate a project, we need to compute NPV: PV ( Proj ) = X t =0 CF t (1 + r ) - t Determining CF t for each time t requires care. Some natural questions include: Can we use the estimated accounting incomes from the project as CF in the formula? for the project? What if the new project hurts the sale of existing product? 2/16
Introduction Measuring CF on an incremental basis Depreciation Incremental Cash Flows Matter 1 Cash ﬂows matter, not accounting earnings (e.g., need to exclude depreciation) 2 Ignore sunk costs (i.e., if the cost has already been incurred, exclude it) 3 Opportunity costs matter. NPV > 0 should not guarantee automatic acceptance, particularly if you have to forgo another project with a higher NPV. 4 Side eﬀects like erosion and synergy matter. If new product hurts existing product sales, we should recognize that fact 5 Taxes matter: we want incremental after-tax cash ﬂows. 6 Inﬂation matters. 3/16

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Introduction Measuring CF on an incremental basis Depreciation Estimating Cash Flows How to convert accounting numbers and to actual cash ﬂows CF t ? The CF t is the free CF (aka the ﬁnancial CF) Recall that from Chap 2, FCF= Op. CF - CS - ΔNWC Operating Cash Flow = EBIT - Taxes + Depreciation Capital Spending: If equipment is bought or sold after its life, it creates CFs. e.g., (+)ve spending reduces the ﬁnancial CF Change in NWC: when the project retires, net working capital decreases (-)ve ΔNWC or increase in the ﬁnancial CF Depreciation is subject to the tax law and can be computed based on a CCA formula 4/16
Introduction Measuring CF on an incremental basis Depreciation Computing depreciation Capital Cost Allowance (CCA) is the depreciation amount for tax purposes prescribed by CRA has diﬀerent rate by asset classes applies the half-year rule to the ﬁrst year to reduce the incentive to buy assets at the end of the year to pay less tax reduces taxes and, thus, increases cash ﬂow Example: Class 10 has 30% CCA rate (trucks, vans, and computer equipments are in this class). We illustrate the depreciation schedule for a new van bought at \$24,000.

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Ch8supp - Introduction CH.8 Supplementary note CCA...

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