lecture7-350

# lecture7-350 - Free Cash Flows in Finance Calculate future...

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Financial management: lecture 7 Free Cash Flows in Finance Calculate future cash flows

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Financial management: lecture 7 Today’s agenda Review what we have learned in the last week How to calculate the cash flows in the future
Financial management: lecture 7 Some points to remember in calculating free cash flows Depreciation and accounting profit Incremental cash flows Change in working capital requirements Sunk costs Opportunity costs Forget about financing

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Financial management: lecture 7 Cash flows, accounting profit and depreciation Discount actual cash flows Using accounting income, rather than cash flows, could lead to wrong investment decisions Don’t treat depreciation as real cash flows
Financial management: lecture 7 Example A project costs \$2,000 and is expected to last 2 years, producing cash income of \$1,500 and \$500 respectively. The cost of the project can be depreciated at \$1,000 per year. Given a 10% required return, compare the NPV using cash flow to the NPV using accounting income.

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Financial management: lecture 7 Solution (using accounting profit) Year 1 Year 2 Cash Income \$1500 \$ 500 Depreciation -\$1000 -\$1000 Accounting Income + 500 - 500 Accounting NPV = 500 1.10 + - = 500 110 32 2 ( . ) \$41.
Financial management: lecture 7 Solution (using cash flows) Today Year 1 Year 2 Cash Income \$1500 \$ 500 Project Cost -2000 Free Cash Flow -2000 +1500 + 500 14 . 223 \$ ) 10 . 1 ( 500 ) 10 . 1 ( 1500 -2000 = NPV Cash 2 1 - = + +

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Forget about financing When valuing a project, ignore how the project is financed. You can assume that the firm is financed
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lecture7-350 - Free Cash Flows in Finance Calculate future...

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