FIN 302 Lecture Notes - Lecture 9: Airtran Airways, Capital Expenditure, Coca-Cola Cherry

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13 Apr 2017

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Lecture 9: estimating cash flows - part 1. The only cash flows that matter for project analysis are those that will occur only if the project is undertaken. Incremental cash flows - all changes in cash flows that are a direct consequence of implementing the project. Incremental cash flows allow us to value each project without having to analyze all other cash flows of the firm. Investment: companies should pick the projects with the highest npv, which is then added to the firm (southwest) Perspective of the company owner who wants to increase shareholder value - how it will affect the profits. A view of someone who is running a profitable business. Only include that incremental cash - only what changes. No need to charge that cash flow to this project. Part of it - include only the part that is affected by the project. The secretary needs to work a little extra because of the project.

Related Questions

Problem 1

All Techniques- Decision among mutually exclusive investments. Pound industries is attempting to select the best of three mutually exclusive projects. The initial investment and after tax cash inflows associated with these projects are shown in the following table

Cash flow Project A Project B Project C

Initial investment (CF) $80,000 $110,000 $110,000

Cash inflows (CF), T=1 to 5 $25,000 $37,000 $38,500

Calculate the payback period for each project

Calculate the net present value (NPV) of each project, assuming that the fimrm has a cost of capital equal to 11%

Calculate the internal rate of return (IRR) for each project

Indicate which project you would recommend

A-the payback period of project A is ___years

the payback period of project B is ___years

the payback period of project C is ___years

B-the NPV of project A is $____

the NPV of project B is $____

the NPV of project C is $____

C- The IRR of project A is _____

The IRR of project B is _____

The IRR of project C is _____

D- which project would you recommend?

Project A

Project B

Project C

Problem 2

IRR, investment life, and cash inflows Oak enterprise accepts projects earning more than the firms 15% cost of capital. Oak is currently considering a 10 year project that provides annual cash inflows of $50,000 and requires an initial investment of $328,300

Deter the IRR of the project is it acceptable

Assuming that the cash inflos continue to be $50,000 per year how many additional years would the flows have to continue to make the project acceptable (that is, to make it have an IRR of 15%?

A. the project IRR is ___%

Is the project acceptable?

Yes or no

B. assuming that the cash inflows continue to be $50,000 per year the number of additional years the flows would have to continue to make the project acceptable at the 15% discount rate is ____ additional years

C) with the given life, initial investment and cost of capital the minimum annual cash inflow that the firm should accept is $______

greyswan843

Given a project's expected cash flows, it is easy to calculate its NPV, IRR, MIRR, payback, and discounted payback. Cash flows are estimated based on information from various sources. There is uncertainty in a project's forecasted cash flows, and some projects are more uncertain and thus riskier than others. In this chapter, we illustrate how project cash flows are estimated, discuss techniques for measuring risk, and discuss how to choose between projects that have significantly different lives, are mutually exclusive, and can be repeated.

The most critical step in capital budgeting analysis is cash flow estimation.

The key is to focus on only

a. relevant

b. net income

c. incremental accounting income or

d. incremental cash flows.

Factors that complicate the analysis are sunk costs, opportunity costs, externalities, changes in net operating working capital, and salvage values. Adjustments to the analysis must be made for

a. inflation

b. interest

c. dividends

We concentrate on expansion project analyses here but there are similarities when analyzing replacement projects.

Give the correct response to each of the following questions.

Which of the following items should be included in the capital budgeting analysis?
a. Sunk costs

b. Interest payments

c. Dividend payments

d. Opportunity costs

An outlay that was incurred in the past and cannot be recovered in the future regardless of whether the project under consideration is accepted is known as
a. Opportunity cost

b. Externality

c. Sunk cost

d. Cannibalization

Which of the following is an example of an opportunity cost?
a. A publisher introduces a new textbook which reduces sales of one of their existing textbooks.
b. A firm has land that can be used in building a new store. If the new store is not built, the firm could sell the land for $2 million (net of taxes).
c. Apple's investment in the iTunes music store boosted sales of its iPod.
d. The cost of a report done 2 years ago to investigate the potential of a new plant and the permits required to build it.
e. Statements a and d are both examples of opportunity costs.
The correct response is -Select-statement astatement bstatement cstatement dstatement eItem 6 .

Which of the following is an example of cannibalization?
a. A publisher introduces a new textbook which reduces sales of one of their existing textbooks.
b. A firm has land that can be used in building a new store. If the new store is not built, the firm could sell the land for $2 million (net of taxes).
c. Apple's investment in the iTunes music store boosted sales of its iPod.
d. The cost of a report done 2 years ago to investigate the potential of a new plant and the permits required to build it.
e. Statements c and d are both examples of cannibalization.
The correct response is -Select-statement astatement bstatement cstatement dstatement eItem 7 .

PLEASE ONLY ANSWER QUESTION 1.6 - 1.11

Merafe Mining is evaluating the possibility of adding a new product line to its product mix. Because the exercise requires a detailed analysis of all possible risk scenarios or cases, EY was contracted to perform capital budgeting analysis for Merafe. The new machinery would cost Merafe an estimated amount of R200 000. A further R10 000 would be required for shipping charges and additional amount of R30 000 is estimated for installation of the new equipment.
Assume an economic life of 4 year for the machinery and the depreciation is based on MACRS 3-year class. Assume the following MACRS 3-year class depreciate rates:

year 1: 33.33%,

year 2: 44.45%,

year 3: 14.81%,

year 4: 7.41%.
The machinery is expected to have a salvage value of R25 000 after 4 years of use.
The new product line would generate incremental sales of 1 250 units per year for 4 years at an incremental cost of R100 per unit in the first year, excluding depreciation. Each unit can be sold for R200 in the first year. The sales price and cost are both expected to increase by 3% per year. Further, to handle the new line, the companyâs net working capital would have to increase by an amount equal to 12% of sales revenues. Assume companyâs tax rate of 40%, and its overall weighted average cost of capital, which is the risk-adjusted cost of capital for an average project (r), is 10%.
1.2. What is Merafeâs depreciable basis? What are the annual depreciation expenses? (5)
1.3. Calculate the annual sales revenues and costs (other than depreciation). Why is it important to include inflation when estimating cash flows? (5)
1.4. Construct annual incremental operating cash flow statements. (5)
1.5. Estimate the required net working capital for each year, and the cash flow due to investments in net working capital. (3)
1.6. Calculate the after-tax salvage cash flow. (3)
1.7. Calculate the net cash flows for each year. Based on these cash flows and the average project cost of capital, what are the projectâs NPV, IRR, PI, payback, and discounted payback? Do these indicators suggest that the project should be undertaken? (10)
1.8. Perform a sensitivity analysis on the unit sales, salvage value, and cost of capital for the project. Assume each of these variables can vary from its base-case, or expected, value by +-10%, +-20%, and +-30%. Discuss the results. (8)
1.9. Assume that EY is confident of its estimates of all the variables that affect the projectâs cash flows except unit sales and sales price. If product acceptance is poor, unit sales would be only 900 units a year and the unit price would only be R160; a strong consumer response would produce sales of 1 600 units and a unit price of R240. EY believes that there is a 25% chance of poor acceptance, a 25% chance of excellent acceptance, and a 50% chance of average acceptance (the base case).
Use the worst-, base-, and best-case NPVs and probabilities of occurrence to find the projectâs expected NPV, standard deviation, and coefficient of variation. (5)
1.10. Assume that Merafeâs average project has a coefficient of variation in the range of 0.2 to 0.4. Would the new line be classified as high risk, average risk, or low risk? What type of risk is being measured here? (3)
1.11. Merafe typically adds or subtracts 3 percentage points to the overall cost of capital to adjust for risk. Should the new line be accepted? (3)

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FIN 302 Lecture Notes - Lecture 9: Airtran Airways, Capital Expenditure, Coca-Cola Cherry

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