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Lecture 12

BUS 320 Lecture 12: Chapter 12

6 pages21 viewsSpring 2018

Department
Business
Course Code
BUS 320
Professor
Chris Starkey
Lecture
12

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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
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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