Lecture 6_Student_6slides

Lecture 6_Student_6slides - Reminder FIN 221 Lecture 6 CH...

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1 FIN 221 Lecture 6 CH 11 1 Cash Flows and Capital Budgeting Reminder •26 th April, next Monday is a public holiday. • If you are in one of the Monday classes, you can go to any tutorial during the week. Relevant Reading Chapters • 11.1 • 11.2 5 general rules …calculations Nominal vs real cash flows Computing Terminal year FCF (Ignore the discussion related to MACRS) 11.4 Projects with Different lives 4 Cash Flow Cash Flow Cash Flow PV PV PV (1+i) n R (1+k) n Cost of capital Sample Worksheet for NPV analysis Application of the NPV method • Estimation of cash flows is critical then how? • Know what to Include/Exclude in Cash-flows: – Use Cash-flows not accounting income Ild i d f ft – Include side effects – Include opportunity costs – Ignore sunk costs – Exclude financing charges
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2 Application of the NPV method • Only incremental free cash flows are relevant – Additional cash flows to be brought as a result of adopting a new project – Free Cash Flow: Cash flows available for distribution to both shareholder and debt-holders after a firm has made necessary investments in working capital and long-term assets • Include taxation Æ (make cash-flows after-tax) – Use Incremental AFTER-TAX free cash flow • Careful with treatment of Net working capital • Careful with inflation Free Cash Flow Calculation Investments in property Plant, and equipment Other long term assets that Must be made if a project is Tax Deductible Expense 8 Purchased Investments in working capital Items, such as account Receivable, inventory, and Account payable, that must be made if the project is pursued. FCF Example • Suppose you work at an outdoor performing arts centre and are evaluating a project to increase the number of seats by building FOUR new box seating areas and adding 5,000 seats for the general public. Each box seating area is expected to generate $400,000 in incremental annual revenue while each of the new seats for the general public will generate $2,500 in incremental annual revenue. The incremental expenses associated with the new boxes and seating will amount to 60% of the revenues. The new construction will cost $10 million and will be fully depreciated on a straight-line basis over the 10-year life of the project. The centre will have to invest $1mil
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Lecture 6_Student_6slides - Reminder FIN 221 Lecture 6 CH...

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