# ch11 - CHAPTER11 Analysis Relevantcashflows Typesofrisk...

• Notes
• Midommab
• 37

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11-1 CHAPTER 11 Cash Flow Estimation and Risk  Analysis Relevant cash flows Incorporating inflation Types of risk Risk Analysis

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11-2 Proposed Project Total depreciable cost Equipment: \$200,000 Shipping: \$10,000 Installation: \$30,000 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
11-3 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%

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11-4 Determining project value Estimate relevant cash flows Calculating annual operating cash flows. Identifying changes in working capital. Calculating terminal cash flows. 0 1 2 3 4 Initial OCF 1 OCF 2 OCF 3 OCF 4 Costs + Terminal CFs NCF 0 NCF 1 NCF 2 NCF 3 NCF 4
11-5 Initial year net cash flow Find  Δ  NOWC.  in inventories of \$25,000 Funded partly by an  in A/P of \$5,000 Δ  NOWC = \$25,000 - \$5,000 = \$20,000 Combine  Δ  NOWC with initial costs. Equipment         -\$200,000    Installation       -40,000    Δ  NOWC       -20,000 Net CF 0 -\$260,000

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11-6 Determining annual  depreciation expense Year Rate   x  Basis Depr   1 0.33   x \$240 \$  79   2 0.45   x  240   108   3 0.15   x  240       36   4 0.07   x  240       17 1.00 \$240 Due to the MACRS  ½ -year convention, a  3-year asset is depreciated over 4 years.
11-7 Annual operating cash flows    1    2    3   4 Revenues   200  200  200 200 - Op. Costs (60%) -120 -120 -120 -120 - Deprn Expense       -79 -108   -36     -17 Oper. Income (BT)      1   -28    44    63 - Tax (40%)     -   -11    18      25 Oper. Income (AT)      1   -17    26    38 + Deprn Expense        79  108    36       17 Operating CF       80    91    62    55

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11-8 Terminal net cash flow Recovery of NOWC \$20,000 Salvage value    25,000 Tax on SV (40%)   -10,000 Terminal CF \$35,000 Q. How is NOWC recovered? Q. Is there always a tax on SV? Q. Is the tax on SV ever a positive cash flow?
11-9 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.

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11-10 Should a \$50,000 improvement cost  from the previous year be included in  the analysis?
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• Spring '10
• jones

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