Capbudget___handout (1)

Capbudget___handout (1) - Chapter 10: Chapter Cash Flows...

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Chapter 10: Chapter 10: Cash Flows & Other Topics Cash Flows & Other Topics in in Capital Budgeting Capital Budgeting

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STUFF YOU NEED TO KNOW --RELEVANT CASH FLOWS Incremental CFs Cash in minus cash out Incidental CFs Directly and indirectly related Sunk costs Don’t matter Opportunity costs Matter
STUFF YOU NEED TO KNOW --DEPRECIATION EXPENSE Two methods: MACRS Depr Xp = cost x percentage percentage determined by life cost, or basis, never changes Straight-line Depreciation XP = (cost - salvage)/ life

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DEPRECIATION EXAMPLE --MACRS Suppose you purchase a new machine for \$100. The machine is in the 3 year MACRS category. Hence, it will be depreciated over FOUR years, as: cost x percentage for yr 1 = 100 x .33 = \$33 cost x percentage for yr 3 = 100 x .45 = \$45 cost x percentage for yr 3 = 100 x .15 = \$15 cost x percentage for yr 4 = 100 x .07 = \$7
DEPRECIATION EXAMPLE --STRAIGHT-LINE On a straight-line system, a \$100, 3- year machine will be depreciated over THREE years, as: Depr. in yr 1 = (cost - salvage)/life = 33.34 Depr. in yr 2 = (cost - salvage)/life = 33.33 Depr. in yr 3 = (cost - salvage)/life = 33.33

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STUFF YOU NEED TO KNOW --WORKING CAPITAL Many projects require an increase in working capital (inventory, cash, A/R). The standard convention is that working capital (WC) is included in the calculation of initial outflow and is reversed at the end of the project. Increased WC is an outflow at t=0 and an inflow at the end of the project. What about a decrease in WC ?
STUFF YOU NEED TO KNOW --TAXES Two situations Income tax -- usually a fixed marginal rate Tax on sale of equipment Calculate Book Value: Cost - Acc. Depr If BV < sale price, then there is a taxable gain If BV > sale price, then there is a taxable loss

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STUFF YOU NEED TO KNOW --TAXES Tax on sale of equipment: Example #1 Cost = 1000; Acc Depr = 400; tax rate = 40% BV = 1000-400 = \$600 Sale price=\$100 Loss = 600 – 100 = \$500 Tax shield = 500 x .4 = \$200 This represents a real tax savings!!! CF from sale = \$100 + \$200 = \$300
STUFF YOU NEED TO KNOW --TAXES Tax on sale of equipment: Example #2 Cost = 1000; Acc Depr = 400; tax rate = 40% BV = 1000-400 = \$600 Sale price=\$800 gain = 800 – 600 = \$200 Tax liability = 200 x .4 = \$80 This represents a real cash outflow!!! CF from sale = \$800 - \$80 = \$720

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Capital Budgeting Capital Budgeting : the process of planning : the process of planning for purchases of for purchases of long-term long-term assets.
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This note was uploaded on 03/06/2012 for the course BUS M 201 taught by Professor Mcgregor during the Fall '11 term at BYU.

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Capbudget___handout (1) - Chapter 10: Chapter Cash Flows...

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