Chap008(WW-FIN357)NT - 8-1Chapter Outline8.1 Incremental...

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Unformatted text preview: 8-1Chapter Outline8.1 Incremental Cash Flows8.2 Capital Budgeting Example8.3 Inflation and Capital Budgeting8.4 Alternative Definitions of Cash Flow8.5 Investments of Unequal Lives8.6 Additional Capital Budgeting Examples8-2Key Concepts and SkillsDetermine the relevant cash flows for various types of capital investmentsCompute depreciation for tax purposesIncorporate inflation into capital budgetingUnderstand the various methods for computing operating cash flowApply the Equivalent Annual Cost approach8-38.1 Incremental Cash FlowsDefinition:Corporate cash flows withprojectminusCorporate cash flows withoutprojectIncremental cash flows are the changesin the firms cash flows that occur as a directconsequence of accepting the project.8-4Incremental Cash Flow ConceptsCash FlowsNot Accounting EarningsEvaluating a project involves using accounting numbers to calculate cash flowsTreatment of depreciationSunk costs are not relevantSuppose $100,000 had been spent last year to improve the proposed production line site.Should this be included in the analysis?8-5Incremental Cash FlowsOpportunity costs matterSuppose the proposed plant space can be leased out for $25,000 a year. Will this affect the analysis?Side effects (externalities) matterIf the new product will decrease sales of the firms other products by $50,000 per year, will this affect the analysis? Positive and negative externalities8-6Incremental Cash FlowsInterest Expense and Dividends Should cash flows include interest expense and dividends? Treatment of inflationShould cash flows be discounted at nominal or real rates?Tax treatment8-7Estimating Cash FlowsCash Flows from OperationsOperating Cash Flow = EBIT Taxes + Deprec.Net Capital SpendingSalvage value (after tax).Changes in Net Working CapitalInitial investment Change in net working capitalRecovery at conclusion of project8-88.2 Capital Budgeting ExampleProposed ProjectCost = $200,000 + $10,000 shipping + $30,000 installation.Depreciable cost = $240,000.Inventories will rise by $25,000 and payables will rise by $5,000.Economic life = 4 years.Salvage value = $25,000.8-9Capital Budgeting ExampleMACRS 3-year class.Incremental annual gross sales = $250,000.Annual cash operating costs = $125,000.Tax rate = 40%.Cost of capital = 10%.8-101234InitialOutlayOCF1OCF2OCF3OCF4+ TerminalCFNCFNCF1NCF2NCF3NCF4Set up a cash flow time line8-11Net Investment Outlay at t($000s)EquipmentFreight + Install.Change in NWCNet CF($200)(40)(20)($260)NWC= $25,000 - $5,000= $20,000.8-12DepreciationBasis = Cost + Shipping +Installation =$240,000Year1234% 0.330.450.150.07Depr....
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Chap008(WW-FIN357)NT - 8-1Chapter Outline8.1 Incremental...

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