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Unformatted text preview: ent value by simply changing the value in the interest rate cell. Download free ebooks at 30 Evaluation of Long-Term Projects Analytics for Managerial Decision Making 5.3 Emphasis on After Tax Cash Flows Please click the advert In computing NPV, notice that the focus is on cash flows, not “income.” Items like depreciation do not impact the cash flows, and are not included in the present value calculations. That is why the illustration for Markum Real Estate did not include deductions for deprecation. However, when applying net present value considerations in practice, one must be well versed in tax effects. Some noncash expenses like deprecation can reduce taxable income, which in turn reduces the amount of cash that must be paid for taxes. Therefore, cash inflows and outflows associated with a particular investment should be carefully analyzed on an after-tax basis. This often entails the preparation of pro forma cash flow statements and consultation with professionals well versed in the details of specific tax rules! Download free ebooks at 31 Evaluation of Long-Term Projects Analytics for Managerial Decision Making As a simple illustration, let’s assume that Mirage Company purchases a tract of land with a prolific spring-fed creek. The land cost is $100,000, and $50,000 is spent to construct a water bottling facility. Net water sales amount to $40,000 per year (for simplicity, assume this amount is collected at the end of each year, and is net of all cash expenses). The bottling plant has a five-year life, and is depreciated by the straight-line method. Land is not depreciated. At the end of five years, it is anticipated that the land will be sold for $100,000. Mirage has an 8% cost of capital, and is subject to a 35% tax rate on profits. The following spreadsheet shows the calculation of annual income and cash flows in blue. The annual cash flow from water sales (not the net income!) is incorporated into the schedule of all cash flows. The annual net cash flows are then multiplied by the appropr...
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