03FCFandSensitivity

03FCFandSensitivity - FreeCashFlowandDiscounted...

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Free Cash Flow and Discounted  Cash Flow Valuation
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Free Cash Flow Approach FCF: The expected after-tax cash flows of an all  equity firm These cash flows ignore the tax savings the firm  gets from debt financing. Plan of attack Step 1: Estimate the Free Cash Flows Step 2: Account for the effect of financing on value Preview: two ways to account for a tax shield Adjust the discount rate (WACC method) Adjust the cash-flow estimate (APV method)
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Count  all   incremental after-tax  cash- flows allowing for reasonable  inflation All Incremental Include: Incidental effects Working capital and follow-on CAPX Opportunity Costs Ignore:  Sunk costs Average payoffs After-Tax Be consistent in your treatment of inflation.
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Questions about adjusting CFs 1. Should CFs include interest expense?  Dividends? _____ The WACC includes all costs of capital. So if we discount  at the WACC,  deducting interest and dividends would be  “double counting.” 1. Suppose $50,000 had been spent last year to  improve the building.  Should this cost be included  in the analysis? _____ This is a sunk cost. 1. Suppose the plant could be leased out for $25,000  a year.  Would this affect the analysis? _____  Accepting project means foregoing $25,000.   Opportunity cost: Opportunity cost= $25,000(1 - T)    If taxes are 40% then,    = $25,000(0.6)   = $15,000 annual cost.
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Questions about adjusting CFs 4. If Project X would decrease CF from the firm’s  other products, would this affect the analysis? _____ 
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03FCFandSensitivity - FreeCashFlowandDiscounted...

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