Chapter 10

Chapter 10 - 1 PrinciplesofFinanceFIN3100 Chapter10 Cash...

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Principles of Finance – FIN 3100 Chapter 10  – Cash Flow Estimation 1 Patty Robertson
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Agenda Review the importance of cash flow and the  distinction between cash flow and profits. Identify incremental (relevant) cash flows. Calculate depreciation and asset cost recovery. Measure and forecast the various sources of  cash flow that arise from the investment and  2
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Capital Budgeting Decision A firm makes  capital budgeting  ( or   asset investment decisions by deciding how to spend money investing in  projects that enhance firm value. 3 Assets $1,000 Debt $400 Equity $600 Total Assets $1,000 Balance Sheet
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Project Cash Flows We are working toward determining total project  cash flows  based on the three sources to decide  if a firm should undertake a project. We’ll look at cash flows like this: 4 Year 0 1 2 3 4 5 Operating Cash Flows - $ 195,400 $ 195,400 $ 195,400 $ 195,400 $ 195,400 $ Net Capital Spending (548,000) $ - $ - $ - $ - $ 106,600 $ Change in Net Working Capital (38,000) $ - $ - $ - $ - $ 38,000 $ Project Cash Flows (586,000) $ 195,400 $ 195,400 $ 195,400 $ 195,400 $ 340,000 $
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Cash Flows In the last chapter, we learned how to use a  project’s estimated cash flows to evaluate  whether to undertake a project. However, there was little discussion regarding  the source (nor reliability) of the cash flow  estimates. In this chapter, we discuss how to estimate and  evaluate the  timing  and  magnitude  of  5
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Profits vs. Cash In Chapter 2, we said cash flow measures the actual  inflow and outflow of cash, while profit is an  accounting measure of periodic performance. A firm can spend operating cash flow but not profits. Thus, cash flow is broader than net income. 6
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Profits vs. Cash Flow This  modified  income  statement  considers  cash flows  from  operations . 7      OCF = EBIT +  Depreciation – Taxes 
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Relevant Cash Flows Relevant  cash flows are those that result  directly from the decision to undertake a project. They are above and beyond existing cash flows  ( stand-alone principal ), so they are considered  incremental   cash flows. If the cash flows would exist regardless of the  project, they are not relevant. 8
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Financing Costs While debt and equity payments  are  cash outflows, in capital  budgeting we include only asset-related cash flows. The financing choices made by the firm are  not  relevant cash  flows. As we will discuss in later chapters, the cost of debt (principal 
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Chapter 10 - 1 PrinciplesofFinanceFIN3100 Chapter10 Cash...

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