公司理财教学资料chap010

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1、Chapter 10Chapter 10Making Capital Making Capital Investment DecisionsInvestment Decisions11/21/2022Chapter Outline Project Cash Flows:A First Look Incremental Cash Flows Pro Forma Financial Statements and Project Cash Flows More about Project Cash Flow Alternative Definitions of Operating Cash Flow

2、 Some Special Cases of Discounted Cash Flow Analysis10-211/21/2022Relevant Cash Flows The cash flows that should be included in a capital budgeting analysis are those that will only occur(or not occur)if the project is accepted These cash flows are called incremental cash flows The stand-alone princ

3、iple-analyze each project in isolation from the firm(on its own merits)by focusing on incremental cash flows10-311/21/2022Asking the Right Question You should always ask yourself“Will this cash flow occur ONLY if we accept the project?”If the answer is“yes,”it should be included in the analysis beca

4、use it is incremental If the answer is“part of it,”then we should include the part that occurs because of the project If the answer is“no,”it should not be included in the analysis because it will occur anyway10-411/21/2022Common Types of Cash Flows Sunk costs costs that have accrued in the past Opp

5、ortunity costs costs of lost options Side effects Positive side effects benefits to other projects Negative side effects costs to other projects Changes in net working capital Taxes(use after-tax cash flows)Do not consider Financing Costs(part of R)10-511/21/2022Pro Forma Statements and Cash Flow Ca

6、pital budgeting relies heavily on pro forma accounting statements,particularly income statements Computing cash flows:Operating Cash Flow(OCF)=EBIT+depreciation taxes OCF=Net income+depreciation(when there is no interest expense)Cash Flow From Assets(CFFA)=OCF net capital spending(NCS)changes in NWC

7、10-611/21/2022Table 10.1(p.310)Pro Forma Income StatementSales(50,000 units at$4.00/unit)Variable Costs($2.50/unit)Gross profitFixed costsDepreciation($90,000/3)EBITTaxes(34%)Net Income$200,000125,000$75,00012,00030,000$33,00011,220$21,78010-711/21/2022Table 10.2 Projected Capital Requirements(balan

8、ce sheet)NWCNFATotalYear0$20,000 90,000$110,0001$20,000 60,000$80,0002$20,000 30,000$50,0003$20,000 0$20,00010-811/21/202211/21/2022Capital spending at the time of project inception(i.e.,the“initial outlay”)includes the following items:+purchase price of the new asset-selling price of the asset repl

9、aced(if applicable)+costs of site preparation,setup,and startup+/-increase(decrease)in tax liability due to sale of old asset at other than book value=net capital spendingTable 10.5(p.311)Projected Total Cash FlowsOCFChange in NWCNCSCFFAYear0-$20,000-$90,000-$110,001$51,780$51,7802$51,780$51,7803$51

10、,78020,000$71,78010-1011/21/2022Making The Decision Now that we have the cash flows,we can apply the techniques that we learned in Chapter 9 Use formulas for PV of discounted cash flows Should we accept or reject the project?10-1111/21/2022More on NWC Why do we have to consider changes in NWC separa

11、tely?GAAP requires that sales be recorded on the income statement when made,not when cash is received GAAP also requires that we record cost of goods sold when the corresponding sales are made,whether we have actually paid our suppliers yet Finally,we have to buy inventory to support sales,although

12、we havent collected cash yet10-1211/21/2022Depreciation The depreciation expense used for capital budgeting should be the depreciation schedule required by the IRS for tax purposes Depreciation itself is a non-cash expense;consequently,it is only relevant because it affects taxes Depreciation tax sh

13、ield=DT D=depreciation expense T=marginal tax rate10-1311/21/2022Computing Depreciation Straight-line Depreciation D=(Initial cost salvage)/number of years Very few assets are depreciated straight-line for tax purposes MACRS(Modified Accelerated Cost Recovery System)p.316 Need to know which asset cl

14、ass is appropriate for tax purposes Multiply percentage given in table by the initial cost Depreciate to zero Mid-year convention10-1411/21/2022After-tax Salvage After-tax salvage is the capital recovery cash flow at project end.If the salvage value is different from the book value of the asset,then

15、 there is a tax effect Book value=initial cost accumulated depreciation After-tax salvage =salvage Tax*(salvage book value)10-1511/21/2022Example:Depreciation and After-tax Salvage You purchase equipment for$100,000,and it costs$10,000 to have it delivered and installed.(What is the capex?)Based on

16、past information,you believe that you can sell the equipment for$17,000 when you are done with it in 6 years.The companys marginal tax rate is 40%.What is the depreciation expense each year and the after-tax salvage in year 6 for each of the following situations?10-1611/21/2022Example:Straight-line

17、Suppose the appropriate depreciation schedule is straight-line D=(110,000 17,000)/6=15,500 every year for 6 years BV in year 6=110,000 6(15,500)=17,000 After-tax salvage=17,000-.4(17,000 17,000)=17,00010-1711/21/2022Example:Three-year MACRS p.316YearMACRS percentD1.3333.3333(110,000)=36,6632.4445.44

18、45(110,000)=48,8953.1481.1481(110,000)=16,2914.0741.0741(110,000)=8,151BV in year 6=110,000 36,663 48,895 16,291 8,151=0After-tax salvage=17,000-.4(17,000 0)=$10,20010-1811/21/2022Example:Seven-Year MACRSYearMACRS PercentD1.1429.1429(110,000)=15,7192.2449.2449(110,000)=26,9393.1749.1749(110,000)=19,

19、2394.1249.1249(110,000)=13,7395.0893.0893(110,000)=9,8236.0892.0892(110,000)=9,812BV in year 6=110,000 15,719 26,939 19,239 13,739 9,823 9,812=14,729After-tax salvage=17,000 .4(17,000 14,729)=16,091.6010-1911/21/2022Example:Replacement Problem Original Machine Initial cost=100,000 Annual depreciatio

20、n=9,000 Purchased 5 years ago Book Value=55,000 Salvage today=65,000 Salvage in 5 years=10,000New Machine Initial cost=150,000 5-year life Salvage in 5 years=0 Cost savings=50,000 per year 3-year MACRS depreciationRequired return=10%Tax rate=40%10-2011/21/2022Replacement Problem Computing Cash Flows

21、 Remember that we are interested in incremental cash flows If we buy the new machine,then we will sell the old machine What are the cash flow consequences of selling the old machine today instead of in 5 years?10-2111/21/2022Replacement Problem Pro Forma Income StatementsYearCost SavingsDepr.New Old

22、Increm.EBITTaxesNI150,00049,9959,00040,9959,0053,6025,403250,00066,6759,00057,675(7,675)(3,070)(4,605)350,00022,2159,00013,21536,78514,71422,071450,00011,1159,0002,11547,88519,15428,731550,00009,000(9,000)59,00023,60035,40010-2211/21/2022Replacement Problem Incremental Net Capital Spending Year 0 Co

23、st of new machine=150,000(outflow)After-tax salvage on old machine=65,000-.4(65,000 55,000)=61,000(inflow)Incremental net capital spending=150,000 61,000=89,000(outflow)Year 5 After-tax salvage on old machine=-10,000(outflow because we no longer receive this)10-2311/21/2022Replacement Problem Cash F

24、low From AssetsYearOCFNCS In NWCCFFA0-89,0000-89,000146,39846,398253,07053,070335,28635,286430,84630,846526,400-10,000016,40010-2411/21/2022Replacement Problem Analyzing the Cash Flows Now that we have the cash flows,we can compute the NPV and IRR Enter the cash flows Compute NPV=54,801.74 Compute I

25、RR=36.28%Should the company replace the equipment?10-2511/21/2022Other Methods for Computing OCF Bottom-Up Approach Works only when there is no interest expense OCF=NI+depreciation Top-Down Approach OCF=Sales Cash Costs Taxes Dont subtract non-cash deductions Tax Shield Approach OCF=(Sales Costs)(1

26、T)+Depreciation*T10-2611/21/2022Example:Cost Cutting Your company is considering a new computer system that will initially cost$1 million.The system is expected to last for five years and will be depreciated using 3-year MACRS.The system is expected to have a salvage value of$50,000 at the end of ye

27、ar 5.It will save$300,000 per year in inventory and receivables management costs.There is no impact on net working capital.The marginal tax rate is 40%.The required return is 8%.Click on the Excel icon to work through the example10-2711/21/2022Example:Setting the Bid Price Consider the following inf

28、ormation:Army has requested bid for multiple use digitizing devices(MUDDs)Deliver 4 units each year for the next 3 years Labor and materials estimated to be$10,000 per unit Production space leased for$12,000 per year Requires$50,000 in fixed assets with expected salvage of$10,000 at the end of the p

29、roject(depreciate straight-line)Require initial$10,000 increase in NWC Tax rate=34%Required return=15%10-2811/21/2022Example:Equivalent Annual Cost Analysis Burnout Batteries Initial Cost=$36 each 3-year life$100 per year to keep charged Expected salvage=$5 Straight-line depreciation Long-lasting Ba

30、tteries Initial Cost=$60 each 5-year life$88 per year to keep charged Expected salvage=$5 Straight-line depreciationThe machine chosen will be replaced indefinitely and neither machine will have a differential impact on revenue.No change in NWC is required.The required return is 15%,and the tax rate

31、 is 34%.10-2911/21/2022Quick Quiz How do we determine if cash flows are relevant to the capital budgeting decision?What are the different methods for computing operating cash flow and when are they important?What is the basic process for finding the bid price?What is equivalent annual cost and when

32、should it be used?10-3011/21/2022Comprehensive Problem A$1,000,000 investment is depreciated using a seven-year MACRS class life.It requires$150,000 in additional inventory and will increase accounts payable by$50,000.It will generate$400,000 in revenue and$150,000 in cash expenses annually,and the

33、tax rate is 40%.What is the incremental cash flow in years 0,1,7,and 8?10-3111/21/2022Key Concepts and Skills Understand how to determine the relevant cash flows for various types of proposed investments Understand the various methods for computing operating cash flow Understand how to set a bid price for a project Understand how to evaluate the equivalent annual cost of a project10-3211/21/2022