WFF&BWFM5013_CFEst-New Project - Projects CashFlowEstimation And Risk MarketFactors\/Considerations EconomicConditions FirmFactors\/Considerations

WFF&BWFM5013_CFEst-New Project - Projects...

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Project’s  Cash Flow Estimation And  Risk
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2 Market Factors/Considerations Economic Conditions Government Regulations and Rules Competitive Environment Firm Factors/Considerations Normal Operations Financing Policy Investing Policy Dividend Policy Investor Factors/Considerations Income/Savings Age/Lifestyle Interest Rates Risk Attitude Net Cash Flows, CF Rates of Return, r = CF 1 (1 + r ) 1 + CF 2 (1 + r ) 2 + ... + CF N (1 + r ) N = N Σ t = 1 CF t (1 + r ) t ^ ^ ^ ^
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3 Cash Flow Estimation Most important and most difficult step in the  analysis of a capital project Financial staff’s role includes: Coordinating other departments’ efforts Ensuring that everyone uses the same set of  economic assumptions Making sure that no biases are inherent in  forecasts
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4 Relevant Cash Flows Cash Flow Versus Accounting Income Cash Flows that contributes to investment  project 
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5 Cash Flow Versus  Accounting Income 2009 Situation    Accounting Profits Cash Flows Sales $50,000     $50,000   Costs except depreciation (25,000) (25,000) Depreciation (15,000)           -- Net operating income or  cash flow           $10,000 $25,000 Taxes based on operating income (30%) (3,000) (3,000) Net income or  net cash flow $7,000 $22,000 Net cash flow =  Net income plus depreciation =  $7,000 + $15,000 = $22,000
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6 Cash Flow Versus  Accounting Income 2013 Situation Accounting Profits Cash Flows Sales $50,000   $50,000   Costs except depreciation (25,000) (25,000) Depreciation (5,000)          -- Net operating income or cash flow $20,000 $25,000 Taxes based on operating income (30%) (6,000) (6,000) Net income or net cash flow $14,000 $19,000 Net cash flow =  Net income plus depreciation  = $14,000 + $5,000 = $19,000
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7 Project’s forecast Estimated sales for the next 4 years:$30,000 per yearVariable cost$18,000 per yearFixed cost  $5,000 per yearInstalled Asset cost=$10,000, depreciated using MACRS 5-yr class.  Yr1Yr2Yr3Yr4Yr5Yr620%32%19%12%12%5% 1. Prepare the Pro-Forma Profit & Loss Account (Income Statement)2. Determine the operating cash flow.
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8 Capital Budgeting Project Evaluation Expansion Project: Expansion Project:  A project that is intended  to increase sales; provides growth to the firm Replacement Analysis: Replacement Analysis:  An analysis involving  the decision of whether to replace an existing,  still productive asset with a new asset
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9 Rules for Estimating Cash Flow Ignore financing costs Disregard sunk costs Include opportunity costs Include indirect costs Include only incremental cash flows (for  replacement project) Adjust for taxes
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10 Determining Relevant Cash Flows Financing Cost: Financing Cost:  Taken in account when using  WACC to discount the after-tax cash flows   Sunk Cost: Sunk Cost:  A cash outlay that already has been  incurred and cannot be recovered Opportunity Cost: Opportunity Cost:  The return on the best  alternative use of an asset Externalities: Externalities:  The effect of accepting a project  on the cash flows in other parts of the firm
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11 Depreciation Systematic charging of a portion of the  costs  of fixed assets against annual revenues over  time. This non-cash charge is considered as a  cash inflow. This non-cash expense is deducted from 
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