Chapter 10

Chapter 10 - Project Evaluation - Chapter 10&11 Yihui...

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Project Evaluation -- Chapter 10&11 Yihui Wang Project Evaluation
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Main Issues • How to calculate cash flows of a proposed project? • How reliable are our NPV estimates? Project Evaluation 2
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Pro Forma Statements and Cash Flows • Capital budgeting relies heavily on pro forma accounting statements, particularly income atements statements • Computing cash flows – refresher Operating Cash Flow (OCF) = EBIT + depreciation – taxes Cash Flow From Assets (CFFA) = OCF – net capital ending (NCS) anges in NWC spending (NCS) changes in NWC Project Evaluation 3
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Depreciation • The depreciation expense used for capital budgeting should be the depreciation schedule required by the S for tax purposes IRS for tax purposes • Depreciation itself is a non-cash expense; consequently, it is only relevant because it affects taxes • Depreciation tax shield = depreciation * T • OCF = (Sales – Cost of goods sold) *(1-T)+ depreciation * T, when there is no interest expense Project Evaluation 4
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Computing Depreciation • Straight-line depreciation D = Initial cost/ number of years ery few assets are depreciated straight e for tax Very few assets are depreciated straight-line for tax purposes • MACRS Need to know which asset class is appropriate for tax purposes ultiply percentage given in table by the initial cost Multiply percentage given in table by the initial cost Depreciate to zero Project Evaluation 5
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Computing Depreciation (MACRS) Project Evaluation 6
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After-tax Salvage • If the salvage value is different from the book value of the asset, then there is a tax effect • Book value = initial cost – accumulated depreciation • After-tax salvage = salvage – T(salvage – book value) Project Evaluation 7
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Net Working Capital • Difference in timing of accounting profits and cash flows Count cash flow when it is received • Major projects require an additional investment in NWC To start production, inventory of raw material is needed When start selling, accounts receivables will increase • Working capital results in a cash outflow in the ginning t picall reco er at the end beginning, typically recover at the end. What does it mean for cash flow calculation? Project Evaluation 8
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Example – Evaluating Shark Attractant Project ppose we think we can sell 50 000 cans of shark attractant Suppose we think we can sell 50,000 cans of shark attractant per year at a price of $4 per can for three years. It costs us about $2.50 per can to make the attractant. Fixed cost, including things as rent on the production facility, will run $12,000 per year. e will need to invest a total of $90 000 in manufacturing We will need to invest a total of $90,000 in manufacturing equipment, and will be 100 percent depreciated straight-line over the three years. The equipment will have no value after three years.
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Chapter 10 - Project Evaluation - Chapter 10&11 Yihui...

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