ADMS 3530 Lecture Notes - Capital Budgeting, Sunk Costs, Tax Shield

76 views2 pages

pearimpala756

29 Jun 2012

School

York University

Department

Administrative Studies

Course

ADMS 3530

Professor

Irvin Pestano

For unlimited access to Class Notes, a Class+ subscription is required.

Document Summary

Incremental cash flow is the difference between the cash flow with the project and the cash flow without project. Lost sales (by one product on the other) = sales erosion. Increase in sales( by one product on the other) = sales synergy. Sunk cost: cost that is already past and cannot be reversed. In finance, the cost of the land would be ,000 and not ,000. Working capital: a lump-sum invested today and recover at project completion. Or we could have working capital invested for three years and then recovered in the last two years. (eg) Adjusted present value (apv) considers the interaction of the investment and the financing decisions. Depreciation tax shield: cf from op= (rev-exp)*(1-t) +(dep*t) We have a tax shield for depreciation because it is a non cash expense which helps in reducing income . Therefore this is a non cash tax shield. Total cash flow = ocf + change in nwc.

Related Questions

Gammy is considering building a facility to manufacture cupcakes to distribute nationally. Your assignment involves both the calculation of cash flows associated with the new investment under consideration and the evaluation of several mutually exclusive projects. Grammy wants you to meet with everyone involved and write a meeting report for the board of directors that includes your recommendation. In addition to the recommendation, you have been asked to respond to a number of questions aimed at understanding the capital-budgeting process. Grammy wants to be sure that she and the board of directors understand cash flow and capital budgeting.

We are considering constructing a building to manufacture cupcakes. Currently we are in the 34 percent marginal tax bracket with a 15 percent required rate of return or cost of capital. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. The following information describes the project:

Cost of new plant and equipment	$7,900,000
Shipping and installation costs	$ 100,000
Unit Sales	Year Units Sold 1 70,000 2 120,000 3 140,000 4 80,000 5 60,000
Sales price per unit	$300/unit in years 1 through 4, $260/unit in year 5
Variable cost per unit	$180/unit
Annual fixed costs	$200,000 per year in years 1 â 5
Working-capital requirements	There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
The depreciation method	Use the simplified straight-line method over 5 years. Assume the plant and equipment will have no salvage value after 5 years.

5. Answer the following questions:

a. Should you focus on cash flows or accounting profits in making the capital-budgeting decision? Should you be interested in incremental cash flows, incremental profits, total free cash flow, or total profits?

b. How does depreciation affect free cash flow?

c. How do sunk costs affect the determination of cash flows?

d. What is the projectâs initial outlay?

e. What are the differential cash flows over the projectâs life?

f. What is the terminal cash flow?

g. Draw a cash-flow diagram for this project.

h. What is its net present value?

i. What is its internal rate of return?

j. Should the project be accepted? Why or why not?

k. How does Genesis 47: 18 â 19 relate to this project and cash flow management?

DDK Industries is considering a new capital budgeting project that will last for three years. The initial investment outlay for project equipment is expected to be $110,000. The equipment will be straight-line depreciated down to zero book value over the three year period. The expected market value of the project assets is forecasted to be $50,000 when the project is liquidated at the end of the third year. Project will require $7,000 Net Working Capital investments in years 1 and 2. The project does not require any investment in fixed assets during years 1 and 3, but a $10,000 investment is projected in year 2. DDKâs cost of capital is 12% and the project does not have a distinct risk profile. DDKâs tax rate is 35%. Based on extensive research, analysts have prepared the following incremental revenues and before tax costs:

Year	0	1	2	3
Sales (Revenues)		100,000	100,000	100,000
- Cost of Goods Sold (50% of Sales)		50,000	50,000	50,000
Depreciation		36,667	36.667	36,667
EBIT		13,333	13,333	13,333
Capital Expenditures	-110,000	0	-10,000	0

Note: Additional fixed capital investments are depreciated straight line over a three-year period; the first depreciation expense is deducted at the end of the year following the investment. The 50,000 liquidation value reflects enhancements realized through capital investments in fixed assets.

The after tax project cash flow including the terminal cash flow for the project in year 3 is closest to ___________?

goldfrog557

Please thoroughly explain.

The Dante Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rae is 34 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project.

	Year 0	Year 1	Year 2	Year 3	Year 4
Invesment	$28,000
Sales Revenue		$12,500	$14,300	$14,800	$11,200
Operating Costs		2,000	2,000	2,000	2,000
Depreciation		7,000	7,000	7,000	7,000
Net working capital spending	350	400	350	300	?

a. Compute the incremental net income of the investment for each year.

b. Compute the incremental cash flows of the investment for each year.

c. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project?

erintoad822

ADMS 3530 Lecture Notes - Capital Budgeting, Sunk Costs, Tax Shield

Document Summary

Get access

Related Documents

ADMS 3530 Chapter Notes - Chapter 9: Cash Flow, Sunk Costs, Working Capital

ADMS 3530 Chapter Notes - Chapter 9: Discounted Cash Flow, Operating Cash Flow, Nominal Interest Rate

ADMS 3530 Lecture Notes - Net Present Value

Related Questions