ch11 - 11-1 CHAPTER 11 Cash Flow Estimation and Risk...

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Unformatted text preview: 11-1 CHAPTER 11 Cash Flow Estimation and Risk Analysis Relevant cash flows Incorporating inflation Types of risk Risk Analysis 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% 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 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-$260,000 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 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%....
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This note was uploaded on 09/05/2011 for the course FIN 4405 taught by Professor Cowan during the Spring '11 term at Fairleigh Dickinson.

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ch11 - 11-1 CHAPTER 11 Cash Flow Estimation and Risk...

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