FIN+4414+-+Capital+Budgeting+-+Other+Topics+-+Chapter+12

FIN+4414+-+Capital+Budgeting+-+Other+Topics+-+Chapter+12 -...

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Capital Budgeting: Other Topics
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Factors to Consider Cash flow vs. accounting income After-tax basis for cash flows Financing charges not included Treat inflation consistently
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Other Factors to Consider Incremental cash flows Sunk costs Opportunity costs Externalities (cannibalization) Shipping and installation Changes in working capital
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Incremental Cash Flow Components of a project’s incremental cash flow include: Costs: Initial investment outlays Benefits: Operating cash flows (net) Terminal cash flows
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Cash Flow Estimation Income Cash Flow Revenue $100.00 $100.00 Depreciation -$20.00 --- Other Costs -$40.00 -$40.00 EBT $40.00 Taxes (40%) -$16.00 -$16.00 Net Income $24.00 $44.00
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Cash Flow Estimation OCF = Net Income + Depreciation OCF = $24.00 + $20.00 = $44.00 OCF = (R - C)(1-T) + TD OCF = ($100 - $40)(1-.40) + ($20)(.40) OCF = $44.00
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Cash Flow Example Assumptions : MACRS Class = 3 Years Life = 4 Years Price = $100,000 Freight & Installation = $20,000 Salvage Value = $30,000
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Cash Flow Example Assumptions : NWC = $10,000 increase in inventory in Year 0 Costs = $50,000 decrease in costs in Years 1-4 Tax Rate = 40% WACC = 10%
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Cash Flow Example Initial Outlay (Year 0) : Price = $100,000 F&I = $ 20,000 NWC = $ 10,000 Total = $130,000 Depreciable Basis
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Cash Flow Example Depreciation Schedule : MACRS Yearly Depreciation Year Rate Depreciation Tax Shelter 1 0.33 $39,600 $15,840 2 0.45 $54,000 $21,600 3 0.15 $18,000 $7,200 4 0.07 $8,400 $3,360 $120,000 $48,000 Total
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Cash Flow Example Year 0 Year 1 Year 2 Year 3 Year 4 Initial Outlay -$130,000 Cost Reduction $50,000 $50,000 $50,000 $50,000 Tax Effect of Reduction -$20,000 -$20,000 -$20,000 -$20,000 Depreciation Tax Shelter $15,840 $21,600 $7,200 $3,360 Salvage Value $30,000 Tax Effect of Salvage -$12,000 NWC Recapture $10,000 Net (Free) Cash Flow -$130,000 $45,840 $51,600 $37,200 $61,360 PV at 10% -$130,000 $41,673 $42,645 $27,949 $41,910 Net Present Value $24,176 Internal Rate of Return 18.08%
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Cash Flow Example What changes would we need to make if this were a replacement rather than a new project? Need to look at the net effect or how the cash flows change from the old to the new project.
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Cash Flow Example Need to consider the sale of old equipment and salvage value. Cash flows would need to be restated to be on an incremental basis. Depreciation would need to be restated on an incremental basis
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Neutral Inflation NCF = NCF in real dollars NPV = Σ NPV = Σ N t = 0 N t = 0 (NCF t )(1+I) t (1+r * )(1+I) t (NCF t ) (1+r * ) (1+I) 1
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Non-neutral Inflation Most projects have non-neutral inflation: Different inflation rates for inflows and outflows Some items, like depreciation, have no inflation Required rates of return are
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Non-neutral Inflation Example Original cost reduction of $50,000 Total costs will increase with inflation so cost reduction will decrease by 5% each year.
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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FIN+4414+-+Capital+Budgeting+-+Other+Topics+-+Chapter+12 -...

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