361-CH12Concise - 12-1CHAPTER 12Cash Flow Estimation and...

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Unformatted text preview: 12-1CHAPTER 12Cash Flow Estimation and Risk AnalysisRelevant cash flowsIncorporating inflationTypes of riskRisk Analysis12-2Proposed ProjectTotal depreciable costEquipment: $200,000Shipping: $10,000Installation: $30,000Changes in working capitalInventories will rise by $25,000Accounts payable will rise by $5,000Effect on operationsNew sales: 100,000 units/year @ $2/unitVariable cost: 60% of sales12-3Proposed ProjectLife of the projectEconomic life: 4 yearsDepreciable life: MACRS 3-year classSalvage value: $25,000Tax rate: 40%WACC: 10%12-4Determining project valueEstimate relevant cash flowsCalculating annual operating cash flows.Identifying changes in working capital.Calculating terminal cash flows.0 1 2 3 4Initial OCF1OCF2OCF3OCF4Costs+TerminalCFs NCFNCF1NCF2NCF3NCF412-5Initial year net cash flowFind NOWC. in inventories of $25,000Funded partly by an in A/P of $5,000 NOWC = $25,000 - $5,000 = $20,000Combine NOWC with initial costs.Equipment -$200,000 Installation -40,000 NOWC -20,000Net CF-$260,00012-6Determining annual depreciation expenseYearRate x BasisDepr 10.33 x$240$ 79 20.45 x 240 108 30.15 x 240 36 40.07 x 240 171.00$240Due to the MACRS -year convention, a 3-year asset is depreciated over 4 years.12-7Annual operating cash flows1234Revenues$200.0$200.0 $200.0 $200.0- Op Costs-120.0-120.0-120.0-120.0- Deprn Expense-79.2-108.0-36.0-16.8Operating Income (BT)0.8-28.044.063.2- Tax (40%)0.3-11.217.625.3Operating Income (AT)0.5-16.826.437.9+ Deprn Expense79.2108.036.016.8Operating CF$79.7$91.2$62.4$54.7(Thousands of dollars)12-8Terminal net cash flowRecovery of NOWC$20,000Salvage value 25,000Tax on SV (40%) -10,000Terminal CF$35,000Q. How is NOWC recovered?Q. Is there always a tax on SV?Q. Is the tax on SV ever a positive cash flow?12-9Should financing effects be included in cash flows?No, dividends and interest expense should not be included in the analysis. Financing effects have already been taken into account by discounting cash flows at the WACC of 10%.Deducting interest expense and dividends would be double counting financing costs.12-10Should a $50,000 improvement cost from the previous year be included in the analysis?No, the building improvement cost is a sunk cost and should not be considered....
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This note was uploaded on 01/23/2012 for the course BUS 361 taught by Professor Staff during the Fall '11 term at University of Michigan.

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361-CH12Concise - 12-1CHAPTER 12Cash Flow Estimation and...

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