Chapter12nt[1] - Chapter 12 Estimating Cash Flows on...

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1 Chapter 12 Estimating Cash Flows on Capital Budgeting Projects
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2 Chapter 12 Learning Goals LG1: Explain why we use pro forma statements to analyze cash flows LG2: Identify which cash flows we can incrementally attribute to a proposed project and which ones we can’t LG3: alculate a project’s expected cash flows using the free cash flow approach LG4: Explain how accelerated depreciation affects project cash flows LG5: Calculate free cash flows for replacement equipment LG6: alculate cash flows associated with cost-cutting proposals LG7: xplain and demonstrate the EAC approach to choose between alternative cash streams when projects recur LG8: djust initial project investments to account for flotation costs
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3 Introduction Estimating project cash flows requires us to consider a number of factors: The costs and revenues The impact on existing products’ costs and revenues Whether we will use existing assets or employees If we should include certain charges such as R&D associated with the project Many other details We will use a pro forma analysis of potential projects to answer the question: “what is this project’s impact on the firm’s cash flows if we go forward?”
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4 Sample Project Description Computer Game Price = $39.99 Projected unit sales: Variable cost per game = $4.25 Fixed costs per year = $150,000 Startup costs: Software duplicating machine costing $75,000 Shipping and installation costs of $2,000 Yea r Unit Sales 1 15,000 2 27,000 3 5,000
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5 Duplicating machine will be depreciated straight-line to $5,000 over the life of the project We expect to be able to sell the machine for $2,000 after we are done with it The new game will cut into sales of an older game currently on the market The old game will lose sales of 2,000 units per year throughout the life of the new game Old game sells for $19.99 and has variable costs of $3.50 per unit
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