BUS 320 Lecture 12: Chapter 12
Chapter 12: Cash Flow Estimation and Risk Analysis
Proposed Project
Determining Project Value
Initial Year Investment Outlays
•Total depreciable cost
–Equipment: $200,000
–Shipping and installation: $40,000
•Changes in net operating working capital
–Inventories will rise by $25,000
–Accounts payable will rise by $5,000
•Effect on operations
–New sales: 100,000 units/year @ $2/unit
–Variable cost: 60% of sales
•Life of the project
–Economic life: 4 years
–Depreciable life: MACRS 3-year class
–Salvage value: $25,000
•Tax rate: 40%
•WACC: 10%
•Estimate relevant cash flows
–Calculating annual operating cash flows.
–Identifying changes in net operating working
capital.
–Calculating terminal cash flows: after-tax
salvage value and recovery of NOWC.
Initial OCF1OCF2OCF3OCF4
Costs +
Terminal
CFs
FCF0FCF1FCF2FCF3FCF4
0 1 2 3 4
•Find DNOWC.
–áin inventories of $25,000
–Funded partly by an áin A/P of $5,000
–DNOWC = $25,000 –$5,000 = $20,000
•Initial year outlays:
Equipment cost -$200,000
Installation -40,000
CAPEX -240,000
DNOWC -20,000
FCF0-$260,000
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Determining Annual Depreciation Expense
Project Operating Cash Flows
Terminal Cash Flows
• How is NOWC recovered?
• Is there always tax on salvage value?
• Is the tax on salvage value ever a positive cash flow?
Should financing effects be included in cash flows?
Should a $50,000 improvement cost from the previous year be included in the analysis?
Year Rate x Basis Deprec.
1 0.33 x $240 $ 79
2 0.45 x 240 108
3 0.15 x 240 36
4 0.07 x 240 17
1.00 $240
Due to the MACRS ½-year convention, a 3-year
asset is depreciated over 4 years.
(Thousands of dollars) 1 2 3 4
Revenues 200.0 200.0 200.0 200.0
–Op. costs -120.0 -120.0 -120.0 -120.0
–Deprec. expense -79.2 -108.0 -36.0 -16.8
EBIT 0.8 -28.0 44.0 63.2
–Tax (40%) 0.3 -11.2 17.6 25.3
EBIT(1 –T) 0.5 -16.8 26.4 37.9
+ Depreciation 79.2 108.0 36.0 16.8
EBIT(1 –T) + DEP 79.7 91.2 62.4 54.7
Salvage value $25
-Tax on SV (40%) 10
AT salvage value $15
+ DNOWC
Terminal CF $35
20
(Thousands of dollars)
FCF4= EBIT(1 –T) + DEP –CAPEX –DNOWC
= $54.7 + $35
= $89.7
•No, dividends and interest expense should not
be included in the analysis.
•Financing effects have already been taken into
account by discounting cash flows at the
WACC of 10%.
•Deducting interest expense and dividends
would be “double counting” financing costs.
•No, the building improvement cost is a sunk
cost and should not be considered.
•This analysis should only include incremental
investment.
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Document Summary
Chapter 12: cash flow estimation and risk analysis. Shipping and installation: ,000: changes in net operating working capital. Accounts payable will rise by ,000: effect on operations. Variable cost: 60% of sales: life of the project. Salvage value: ,000: tax rate: 40, wacc: 10% Determining project value: estimate relevant cash flows. Calculating terminal cash flows: after-tax capital. salvage value and recovery of nowc. Initial year investment outlays: find d nowc. Funded partly by an in a/p of ,000. D nowc = ,000 ,000 = ,000: initial year outlays: Due to the macrs -year convention, a 3-year asset is depreciated over 4 years. Fcf4 = ebit(1 t) + dep capex d nowc. Should financing effects be included in cash flows: no, dividends and interest expense should not, financing effects have already been taken into be included in the analysis. account by discounting cash flows at the. Wacc of 10%: deducting interest expense and dividends would be double counting financing costs.
