Estimating Cash Flows in Practice •Taxes and Depreciation –“Accelerated” depreciation under the Modified Accelerated Cost Recovery System (MACRS), has been acceptable for U.S. federal tax calculations since the Tax Reform Act of 1986 –Allows a firm to allocate more of the depreciation expense to the early years of a project, realize larger tax savings sooner, and increase the present value of the tax shield FIN 300 - Cap Budget CF's 28
MACRS Depreciation Schedules by Allowable Recovery Period FIN 300 - Cap Budget CF's 29
MACRS Depreciation Calculations for the Performing Arts Center Project FIN 300 - Cap Budget CF's 30
Estimating Cash Flows in Practice •Compute Terminal-Year FCF –FCF in the last, or terminal, year of a project often includes cash flows not typically included in the calculations for prior years –Long-term assets and working capital that are no longer needed to support the project may be sold and funds used in other ways –Net cash flows from the sale of assets and the impact of the sale on the firm’s taxes are included in the terminal-year FCF FIN 300 - Cap Budget CF's 31
FCF Calculations and NPV FIN 300 - Cap Budget CF's 32
FCF Calculations and NPV FIN 300 - Cap Budget CF's 33
Forecasting Free Cash Flows •Cash Flows from Operations –To forecast incremental cash flows from operations, forecast the incremental net revenue, operating expenses, depreciation, and amortization •Analysts often distinguish between types of costs when forecasting operating expenses –fixed costs that do not change with the units of output –variable costs that change with every unit of output FIN 300 - Cap Budget CF's 34
Forecasting Free Cash Flows •Investment Cash Flows –Capital expenditure forecasts reflect the expected level of investment during each year of a project’s life, including inflows from salvage value and tax costs or benefits associated with asset sales FIN 300 - Cap Budget CF's 35
Forecasting Free Cash Flows •Investment Cash Flows –Four working capital items are included in the cash flow forecasts of an NPV analysis •cash and cash equivalents •accounts receivable •Inventories •accounts payable. FIN 300 - Cap Budget CF's 36
Special Cases •The Cost of Using an Existing Asset –When calculating incremental after-tax cash flows, include opportunity costs that may not be directly observable –Sometimes incremental cash flows have to be computed by using the EAC for a given set of cash flows, then adjusting the EAC by the appropriate discount rate and time if the EAC is not in present-value form FIN 300 - Cap Budget CF's 37
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