Chap008(WW-FIN357)NT

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 Skills•Determine the relevant cash flows for various types of capital investments•Compute depreciation for tax purposes•Incorporate inflation into capital budgeting•Understand the various methods for computing operating cash flow•Apply the Equivalent Annual Cost approach8-38.1 Incremental Cash FlowsDefinition:Corporate cash flows withprojectminusCorporate cash flows withoutproject•Incremental cash flows are the changesin the firm’s cash flows that occur as a directconsequence of accepting the project.8-4Incremental Cash Flow Concepts•Cash Flows—Not Accounting Earnings–Evaluating a project involves using accounting numbers to calculate cash flows–Treatment of depreciation•Sunk costs are not relevant–Suppose $100,000 had been spent last year to improve the proposed production line site.–Should this be included in the analysis?8-5Incremental Cash Flows•Opportunity costs matter–Suppose the proposed plant space can be leased out for $25,000 a year. –Will this affect the analysis?•Side effects (externalities) matter–If the new product will decrease sales of the firm’s other products by $50,000 per year, will this affect the analysis? –Positive and negative externalities8-6Incremental Cash Flows•Interest Expense and Dividends –Should cash flows include interest expense and dividends? •Treatment of inflation–Should cash flows be discounted at nominal or real rates?•Tax treatment8-7Estimating Cash Flows•Cash Flows from Operations–Operating Cash Flow = EBIT – Taxes + Deprec.–Net Capital Spending–Salvage value (after tax).•Changes in Net Working Capital–Initial investment –Change in net working capital–Recovery at conclusion of project8-88.2 Capital Budgeting ExampleProposed Project•Cost = $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 Example•MACRS 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($000’s)EquipmentFreight + Install.Change in NWCNet CF($200)(40)(20)($260)ΔNWC= $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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