FIN351_Chapter9

FIN351_Chapter9 - 1 Chapter 9 Discounted Cash-Flow Analysis...

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Unformatted text preview: 1 Chapter 9 Discounted Cash-Flow Analysis Capital Budgeting Decision 2 Topics Covered Identifying Cash Flows Discounted Cash Flows, Not Profits Incremental Cash Flows Treatment of Inflation Separate Investment & Financing Decisions Calculating Cash Flows Example: Blooper Industries 3 Cash Flow vs. Accounting Income Discount actual cash flows Using accounting income, rather than cash flow, could lead to erroneous decisions. Don’t treat depreciation as real cash flows 4 Cash Flow vs. Accounting Income 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. 5 Cash Flow vs. Accounting Income 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- = + + (Correct) 6 Cash Flow vs. Accounting Income Year 1 Year 2 Cash Income $1500 $ 500 Depreciation-$1000-$1000 Accounting Income + 500- 500 32 . 41 $ ) 10 . 1 ( 500 1.10 500 = NPV Apparent 2 =- + (Wrong) 7 Incremental Cash Flows Discount incremental cash flows Incremental cash flows are the increased cash flows due to investment Incremental Cash Flow cash flow with project cash flow without project =- 8 Incremental Cash Flows IMPORTANT IMPORTANT Ask yourself this question Would the cash flow still exist if the project does not exist?...
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FIN351_Chapter9 - 1 Chapter 9 Discounted Cash-Flow Analysis...

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