Chapter 12

Chapter 12 - CHAPTER12 Analysis Relevantcashflows...

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12-1 CHAPTER 12 Cash Flow Estimation and Risk  Analysis Relevant cash flows Incorporating inflation Types of risk Risk Analysis
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12-2 Proposed Project A firm is contemplating investing in a new equipment to upgrade its  production.   The equipment will cot $200,000 to purchase, $10,000 to ship and  $30,000 to install.   The use of the new equipment will be able to increase its production by  100,000 units/year which can be sold for $2/unit, but the variable cost is  60% of sales.   The use of the new equipment will also need to increase its inventories  by $25,000 and accounts payable by $5,000.  The new equipment has 4 years in its economic life, but will be  depreciated with a MACRS 3-year depreciation class.  At the end it also  has a salvage value of $25,000.   Given a tax rate of 40% and WACC 10%.  Should the company invest in  this new equipment?
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12-3 Proposed Project Total depreciable cost = $240,000 Equipment: $200,000 Shipping: $10,000 Installation: $30,000 Changes in working capital = $20,000 Inventories will rise by $25,000 Accounts payable will rise by $5,000 Effect on operations = $80,000 (net  operating profit) New sales: 100,000 units/year @ $2/unit Variable cost: 60% of sales
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12-4 Proposed Project Life of the project Economic life: 4 years Depreciable life: MACRS 3-year class Salvage value: $25,000 Tax rate: 40% WACC: 10%
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12-5 Relevant Cash Flows Estimate relevant cash flows 1. Calculating initial cash flows at the initiation of the project 2. Calculating operating cash flows for each of year during  operation by taking into account changes in working capital and  depreciation 3. Calculating terminal cash flows.
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12-6 Relevant Cash Flows Initial Cash Flows  Those at the initiation of the project, mainly initial  investment for undertaking the project Operation Cash Flows Cash flows for each of year resulting from the operation,  mainly due to increasing sales, reduced costs, changes in  net working capital, and depreciation  Terminal Cash Flows Additional cash flows taking place only at the end of the life of  the project, mainly due to the recovery of additional net  working capital and salvage value of the investment project
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12-7 Relevant Cash Flows 0 1 2 3 4 Initial OCF 1 OCF 2 OCF 3 OCF 4 Costs + Terminal CFs NCF 0 NCF 1 NCF 2 NCF 3 NCF 4
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12-8 Initial year net cash flow Find Δ NOWC.  in inventories of $25,000 Funded partly by an  in A/P of $5,000 Δ NOWC = $25,000 - $5,000 = $20,000 Combine Δ NOWC with initial costs.
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Chapter 12 - CHAPTER12 Analysis Relevantcashflows...

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