Lect 03 Fin 221 web

Lect 03 Fin 221 web - Managerial Finance Lecture 3 Capital...

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1 Managerial Finance Lecture 3 Capital Budgeting
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2 Class 2: Takeaways Earnings (net income) are not free cash flows The value of investments (firms) is determined by discounted FCFs Changes in “value drivers” matter for investors FCFs Formula: Revenue Expenses - Expenses = EBIT - Tax on EBIT = NOPAT + Depreciation - CAPEX 2 CAPEX - NWC FCF EBIT=Earnings Before Interest and Taxes NOPAT=Net operating profits after tax CAPEX= capital expenditures NWC=Change in Net Working Capital
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3 Not all projects are NPV>0 Fund Goes Down Blind Alley; Developer Set Up Vehicle to Invest in Banks but Couldn't 'Make the Numbers Work' By Robin Sidel 29 September 2011 Real-estate developer Stephen Ross and his partners spent more than a year digging into U.S. banks, including more than 100 with loans to local bakeries, gas stations and amusement parks. They hoped to spend about $1.1 billion buying or investing in lenders. But the deeper they went, the worse things looked. As a result, Related Cos., the New York firm in which Mr. Ross is chief executive, gave back the money it raised from roughly 150 investors. The firm did find several investments it was interested in but was outbid. 3 Since then, signs of economic improvement have faded , leaving many of the nation's 7,500 banks and savings institutions besieged with troubled assets, weak loan demand, rising regulatory costs and few growth prospects.
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4 FCF Exercise You have decided to start a premium T-shirt business You have decided to start a premium T shirt business Today (Year=0) you buy (and pay for) 100,000 T-shirts at a cost of $10 each • 100% organic Egyptian cotton You expect to sell them during the first week of classes: • Next year: 50K in year=1 • The following year 50K in year=2 Assumptions: • Expected sales price = $20 • Corporate tax rate is 40% • The cost for you (time, overhead, etc) of running this business is zero • You have lots of taxable income from other sources What are the free cash flows in years 0, 1 and 2 ? 4
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5 Solution Y e a r 012 Sales 1,000 COGS 500 EBIT Tax 200 NOPAT 300 Inventory Change in WC (500) 5 FCFs (1,000) 800
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6 Sources of Value Recall our analysis of Callaway’s FX-1 Project Callaway Golf’s cost of capital 4.5% (risk-free rate) + 6% (risk premium) = 10.5% Year 0 Year 1 Year 2 Year 3 Year 4 Free Cash Flow -3 365 39 2362 1 841 1444 NPV = -3,365 + 35 + 1,935 + 1,364 + 969 = $938 -3,365 2,362 1,841 1,444 1.000 0.905 0.819 0.741 0.671 = Present Value (3,365) 35 1935 1364 969 1 (1.105) t 6 This estimate is based on a number of assumptions Sales volume, pricing, development costs, etc.
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Lect 03 Fin 221 web - Managerial Finance Lecture 3 Capital...

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