FNCE10001 Chapter Notes - Chapter 8: Average Selling Price, Capital Budgeting, Accelerated Depreciation

22 views5 pages

orangemole587

25 May 2018

School

University of Melbourne

Department

Finance

Course

FNCE10001

Professor

Asjeet Lamba

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

Capital budget = list of projects and investments a company plans to undertake in the coming year

Ultimate goal is to determine effect of decisions on firm's cash flows and evaluate NPV of cash

flows to assess consequences for the firm's value

Begins by determining the incremental earnings for a project (amount by which firm's earnings

are expected to change as a result of the investment decision)

Revenue and cost estimates

Capital expenditures and depreciation

deduct straight

line depreciation

Interest expenses

do not include interest expenses

Income tax = EBIT x marginal corporate tax rate



Taxes

account for marginal corporate tax rate (tax rate it will pay on an incremental

dollar of pre

tax income

Unlevered net income = (revenue

costs

depreciation) x (1

tax rate)



Unlevered net income

net income that does not include any interest expenses

associated with debt

Incremental earnings forecast

Opportunity costs

not using the resource in an alternative way

Cannibalisation = sales of a new product displace sales of an existing product



Project externalities

indirect effects that may change profits of other business activities

of the firm

Indirect effects on incremental earnings

Fixed overhead expenses

expenses that affect many different areas of the corporation,

only include additional overhead expenses that arise because of the decision to take on

the project

Past research and development expenditures

Unavoidable competitive effects

Sunk costs and incremental earnings

New products typically have lower sales initially, accelerate, plateau and then decline

Average selling price of a product and its cost of production will generally change over

time

Competition tends to reduce profit margins over time

Real

world complexities

Capital budgeting = process of analysing alternative projects and deciding which ones to accept

Forecasting Earnings

Saturday, 29 April 2017 1:12 PM

Principles of Finance Page 1

Unlock document

This preview shows pages 1-2 of the document.
Unlock all 5 pages and 3 million more documents.

Already have an account? Log in

Free cash flow = incremental effect of a project on the firm's available cash, separate from any

financing decisions

Depreciation is not included in cash flow forecast

○

Include actual cash cost of the asset when purchased

○

Capital expenditures and depreciation

NWC = current assets

current liabilities

○

= cash + inventory + receivables

payables

Most projects require the firm to invest in NWC

○

Need to maintain a minimum cash balance to meet unexpected expenditures, and

inventories of raw materials and finished product to accommodate production

uncertainties and demand fluctuations

○

Trade credit = net amount of firm's capital that is consumed as a result of credit

transactions = receivables

payables

○

Increases in NWC represent an investment that reduces cash available to the firm and

free cash flow

○

Net working capital

Calculating free cash flow from earnings:

Calculating free cash flow directly:

= (revenue

costs) x (1

tax rate)

capital expenditure

change in NWC + tax rate x

depreciation

Free cash flow = (revenues

costs

depreciation) x (1

tax rate) + depreciation

capital expenditure

change in NWC

Depreciation tax shield = tax savings that results from the ability to deduct depreciation = tax rate x

depreciation

Calculating the NPV:

Discount its free cash flow at appropriate cost of capital

NPV of project = sum of present values of each free cash flow

Determining Free Cash Flow and NPV

Saturday, 29 April 2017 5:38 PM

Principles of Finance Page 2

Unlock document

This preview shows pages 1-2 of the document.
Unlock all 5 pages and 3 million more documents.

Already have an account? Log in

Document Summary

Capital budget = list of projects and investments a company plans to undertake in the coming year. Capital budgeting = process of analysing alternative projects and deciding which ones to accept. Ultimate goal is to determine effect of decisions on firm"s cash flows and evaluate npv of cash flows to assess consequences for the firm"s value. Begins by determining the incremental earnings for a project (amount by which firm"s earnings are expected to change as a result of the investment decision) Capital expenditures and depreciation - deduct straight-line depreciation. Interest expenses - do not include interest expenses. Taxes - account for marginal corporate tax rate (tax rate it will pay on an incremental dollar of pre-tax income. Income tax = ebit x marginal corporate tax rate. Unlevered net income - net income that does not include any interest expenses associated with debt. Unlevered net income = (revenue - costs - depreciation) x (1 - tax rate)

Related Questions

Wolverine Corp. currently has no existing business in New Zealand but is considering establishing a subsidiary there. The following information has been gathered to assess this project:

The initial investment required is $50 million in New Zealand dollars (NZ$). Given the existing spot rate of $.50 per New Zealand dollar, the initial investment in U.S. dollars is $25 million. In addition to the NZ$50 million initial investment for plant and equipment, NZ$20 million is needed for working capital and will be borrowed by the subsidiary from a New Zealand bank. The New Zealand subsidiary will pay interest only on the loan each year, at an interest rate of 14 percent. The loan principal is to be paid in 10 years.

The project will be terminated at the end of year 3, when the subsidiary will be sold.

The price, demand, and variable cost of the product in New Zealand are as follows:

Year Price Demand Variable Cost

1 NZ$500 40,000 units NZ$30

2 NZ$511 50,000 units NZ$35

3 NZ$530 60,000 units NZ$40

The fixed costs, such as overhead expenses, are estimated to be NZ$6 million per year.

The exchange rate of the New Zealand dollar is expected to be $.52 at the end of Year 1, $.54 at the end of Year 2, and $.56 at the end of Year 3.

The New Zealand government will impose an income tax of 30 percent on income. In addition, it will impose a withholding tax of 10 percent on earnings remitted by the subsidiary. The U.S. government will allow a tax credit on the remitted earnings and will not impose any additional taxes.

All cash flows received by the subsidiary are to be sent to the parent at the end of each year. The subsidiary will use its working capital to support ongoing operations.

The plant and equipment are depreciated over 10 years using the straightâline depreciation method. Since the plant and equipment are initially valued at NZ$50 million, the annual depreciation expense is NZ$5 million.

In three years, the subsidiary is to be sold. Wolverine plans to let the acquiring firm assume the existing New Zealand loan. The working capital will not be liquidated but will be used by the acquiring firm when it sells the subsidiary. Wolverine expects to receive NZ$52 million after subtracting capital gains taxes. Assume that this amount is not subject to a withholding tax.

Wolverine requires a 20 percent rate of return on this project.

Determine the NPV, PI, IRR, MIRR and payback of this project. Should Wolverine accept this project?

Note:

International Capital Budgeting is 95% similar to the evaluation of domestic projects which you have done so far except for three differences:

Interest expense is considered in international capital budgeting, so it should be deducted.

Tax Withholding is additional tax imposed to funds remitted to the parent. This is deducted from the Operating Cash Flows (OCF).

All computations should be done in terms of the foreign current. The exchange rate should be applied to the Free Cash Flows (FCF) at the end to convert the foreign currency to US dollars.

carminejellyfish504

The following Balance Sheet extract relates to the Snapple Company:

Bonds payable $1,000,000

Common Stock $3,000,000

Preferred Stock $2,000,000

Additional Information:

The bonds are 8%, annual coupon bonds, with 9 years to maturity and are currently selling for 95% of par.

The companyâs common shares which have a book value of $25 per share are currently selling at $20 per share.

The company has an equity beta of 1.5 and the current Treasury bill rate is 3.5%. The market risk premium is 1.5%

The preferred dividends are 5% preferred shares with a book value of $100 per share. These shares are currently selling at $80 per share.

The Companyâs tax rate is 35%.

Required:

a) Calculate Snappleâs cost of debt. [5 marks]

b) Calculate Snappleâs cost of equity. [5 marks]

c) Calculate Snappleâs cost of preferred shares. [3 marks]

d) Calculate Snappleâs Weighted Average Cost of Capital [8 marks]

e) Explain why the cost of debt is cheaper than the cost of equity. [3 marks]

f) Explain why the cost of retained earnings is equivalent to the cost of an existing issue of common stock. [4 marks]

g) Outline two (2) reasons why a firmâs cost of capital is critically important. [2 marks]

The Beacon Inc. is considering two mutually exclusive projects, each with an initial investment of $150,000. The companyâs board of directors has set up a 4-year payback requirement and has set its cost of capital at 9%. The cash inflows associated with the two projects are as follows:

Year		*Cash Inflows (CFt)*
Project A		Project B
1	$45,000		$75,000
2	$45,000		$60,000
3	$45,000		$30,000
4	$45,000		$30,000
5	$45,000		$30,000
6	$45,000		$30,000

a) Calculate the payback period for each project. [2 marks]

b) Calculate the NPV for each project at 7% and 9%. [6 marks]

c) Based on b) above which project would you choose and why.[ 2 marks]

d) Briefly explain why firms engage in âcapital rationingâ [2 marks]

e) What are Real Options? What are some major types of real options? [3 marks]

The Lifeâs Good Corporation 2012 income statement shows the following:

Income Statement 2012
Sales	$ 5,250,000
Costs	2,173,000
Other expenses	67,400
Depreciation expense	179,000
EBIT	$ 2,830,600
Interest expense	85,555
EBT	$ 2,745,045
Taxes	89,000
Net income	$ 2,656,045
Dividends	$ 169,000
Addition to retained earnings	$ 2,487,045

Lifeâs Good Corp. also issued $106,700 in new equity during the year and redeemed $65,300 in outstanding long-term debt.

i. Calculate the operating cash flow for the firm. (2 marks) $2,920,600

ii. Calculate the cash flow to creditors. (2 marks) $150,855

iii. Calculate the cash flow to stockholders. (2 marks) 62,300

iv. Define free cash flow (FCF) and state one of the equations for computing FCF. (3 marks)

Clarkâs Drug Store, a medium-size drugstore located in Bridgetown Barbados, is owned and operated by Robert Clark. Clarkâs sells pharmaceuticals, cosmetics, toiletries, magazines, and various novelties. Clarkâs most recent annual net income statement is as follows:

Sales Revenue	$2,600,000
COGS	1,460,000
Wages and Salaries	250,000
Rent	190,000
Depreciation	70,000
Utilities	95,000
Miscellaneous	30,000
Total Expenses	2,095,000
Net Profit before Tax	505,000

Clarkâs sales and expenses have remained relatively constant over the past few years and are expected to continue unchanged in the near future. To increase sales, Clarkâs is considering using some floor space for a small soda fountain. Clarkâs would operate the soda fountain for an initial three-year period and then would reevaluate its profitability. The soda fountain would require an incremental investment of $85,000 to lease furniture, equipment, utensils, and so on. This is the only capital investment required during the three-year period. At the end of that time, additional capital would be required to continue operating the soda fountain, and no capital would be recovered if it were shut down.

The soda fountain is expected to have annual sales of $670,000 and food and materials expenses of $380,000 per year.

The soda fountain is also expected to increase wage and salary expenses by 6% and utility expenses by 5%. Because the soda fountain will reduce the floor space available for display of other merchandise, sales of non-soda fountain items are expected to decline by 10%.

Calculate net incremental cash flows for the soda fountain. (6 marks)

ii. Assume that Clarkâs has the capital necessary to install the soda fountain and that he places a 12% opportunity cost on those funds. Should the soda fountain be installed? Why or why not? (4 marks)

5. âIn order for a project to be acceptable, its required rate of return must exceed the cost of debtâ. Do you agree? In light of the statement, define what is cost of capital and what role does it play in long-term investment decisions? (5 marks)

6. What do you understand by the term net proceeds in context with a bond sale? How do floatation costs affect the net proceeds? (3 marks)

7. Go-geta Corp. issued 10-year bonds 2 years ago at a coupon rate of 6 percent. The bonds make semiannual payments. If these bonds currently sell for 98 percent of par value, what is the YTM? (2 marks)

FV	$1000
PV	$ (980.00)
Coupon	$ 30.00

8. ABC Company has an unusual dividend policy. The company has just paid a dividend of $5 per share and has announced that it will increase the dividend by $2 per share for each of the next four years, and then never pay another dividend. If you required a 9 percent return on the companyâs stock, how much will you pay for a share today? (5 marks)

Dividend D0		5.00
Div increase yrly		2.00
Required return		9.00%
Stock Price
Factor		Price
D (1)	1.09	5.00	4.59
D (2)	1.1881	7.00	5.89
D (3)	1.295029	9.00	6.95
D (4)	1.411582	11.00	7.79

9 âWhile contemplating to create a portfolio, it is imperative to study the correlation amongst the assets that constitute the portfolioâ. Discuss the statement and explain how diversification helps in reducing the risk of the portfolio as compared to the individual risks of constituting assets. (5 marks)

pinkserval13

NIKE:

Need the following ratios to be calculated using the financial sheets copied at the bottom. Each ratio needs to be calculated using the information from 2016. Each ratio also needs to be broken down and illustrated by the step by step process. Finally, please include any and all observations for each ratio and analysis.

1) Common Size analysis

2) Common size vertical analysis & graph

3) Current Ratio

4) Quick Ratio

5) Cash Ratio

6) Inventory Turnover

7) Receivables Turnover

8) Total Asset Turnover

9) Fixed Asset Turnover

10) Gross profit margin

11) Operating Profit margin

12) Net profit margin

13) Return on total assets

14) return on equity

15) basic earning power

16) Deb/net worth ratio

17) debt ratio

18) DuPont System

19) Times-interest-earned

Balance Sheet:

Consolidated Balance Sheets - USD ($) $ in Millions	May 31, 2017	May 31, 2016
Current assets:
Cash and equivalents	$ 3,808	$ 3,138
Short-term investments	2,371	2,319
Accounts receivable, net	3,677	3,241
Inventories	5,055	4,838
Prepaid expenses and other current assets	1,150	1,489
Total current assets	16,061	15,025
Property, plant and equipment, net	3,989	3,520
Identifiable intangible assets, net	283	281
Goodwill	139	131
Deferred income taxes and other assets	2,787	2,422
TOTAL ASSETS	23,259	21,379
Current liabilities:
Current portion of long-term debt	6	44
Notes payable	325	1
Accounts payable	2,048	2,191
Accrued liabilities	3,011	3,037
Income taxes payable	84	85
Total current liabilities	5,474	5,358
Long-term debt	3,471	1,993
Deferred income taxes and other liabilities	1,907	1,770
Commitments and contingencies
Redeemable preferred stock	0	0
Shareholdersâ equity:
Capital in excess of stated value	8,638	7,786
Accumulated other comprehensive (loss) income	(213)	318
Retained earnings	3,979	4,151
Total shareholdersâ equity	12,407	12,258
TOTAL LIABILITIES AND SHAREHOLDERSâ EQUITY	23,259	21,379
Class A Convertible Common Stock
Shareholdersâ equity:
Common stock at stated value	0	0
Class B Common Stock
Shareholdersâ equity:
Common stock at stated value	$ 3	$ 3

Income Statement:

Consolidated Statements of Income - USD ($) $ in Millions	12 Months Ended
Consolidated Statements of Income - USD ($) $ in Millions	May 31, 2017	May 31, 2016	May 31, 2015
Income Statement [Abstract]
Revenues	$ 34,350	$ 32,376	$ 30,601
Cost of sales	19,038	17,405	16,534
Gross profit	15,312	14,971	14,067
Demand creation expense	3,341	3,278	3,213
Operating overhead expense	7,222	7,191	6,679
Total selling and administrative expense	10,563	10,469	9,892
Interest expense (income), net	59	19	28
Other (income) expense, net	(196)	(140)	(58)
Income before income taxes	4,886	4,623	4,205
Income tax expense	646	863	932
NET INCOME	$ 4,240	$ 3,760	$ 3,273
Earnings per common share:
Basic (in dollars per share)	$ 2.56	$ 2.21	$ 1.90
Diluted (in dollars per share)	2.51	2.16	1.85
Dividends declared per common share (in dollars per share)	$ 0.70	$ 0.62	$ 0.54

Cash Flow Sheet

Consolidated Statements of Cash Flows - USD ($) $ in Millions	12 Months Ended
	May 31, 2017	May 31, 2016	May 31, 2015
Cash provided by operations:
Net income	$ 4,240	$ 3,760	$ 3,273
Income charges (credits) not affecting cash:
Depreciation	706	649	606
Deferred income taxes	(273)	(80)	(113)
Stock-based compensation	215	236	191
Amortization and other	10	13	43
Net foreign currency adjustments	(117)	98	424
Changes in certain working capital components and other assets and liabilities:
(Increase) decrease in accounts receivable	(426)	60	(216)
(Increase) in inventories	(231)	(590)	(621)
(Increase) in prepaid expenses and other current assets	(120)	(161)	(144)
(Decrease) increase in accounts payable, accrued liabilities and income taxes payable	(364)	(889)	1,237
Cash provided by operations	3,640	3,096	4,680
Cash used by investing activities:
Purchases of short-term investments	(5,928)	(5,367)	(4,936)
Maturities of short-term investments	3,623	2,924	3,655
Sales of short-term investments	2,423	2,386	2,216
Investments in reverse repurchase agreements	0	150	(150)
Additions to property, plant and equipment	(1,105)	(1,143)	(963)
Disposals of property, plant and equipment	13	10	3
Other investing activities	(34)	6	0
Cash used by investing activities	(1,008)	(1,034)	(175)
Cash used by financing activities:
Net proceeds from long-term debt issuance	1,482	981	0
Long-term debt payments, including current portion	(44)	(106)	(7)
Increase (decrease) in notes payable	327	(67)	(63)
Payments on capital lease and other financing obligations	(17)	(7)	(19)
Proceeds from exercise of stock options and other stock issuances	489	507	514
Excess tax benefits from share-based payment arrangements	177	281	218
Repurchase of common stock	(3,223)	(3,238)	(2,534)
Dividends â common and preferred	(1,133)	(1,022)	(899)
Cash used by financing activities	(1,942)	(2,671)	(2,790)
Effect of exchange rate changes on cash and equivalents	(20)	(105)	(83)
Net increase (decrease) in cash and equivalents	670	(714)	1,632
Cash and equivalents, beginning of year	3,138	3,852	2,220
CASH AND EQUIVALENTS, END OF YEAR	3,808	3,138	3,852
Cash paid during the year for:
Interest, net of capitalized interest	98	70	53
Income taxes	703	748	1,262
Non-cash additions to property, plant and equipment	266	252	206
Dividends declared and not paid	$ 300	$ 271	$ 240

FNCE10001 Chapter Notes - Chapter 8: Average Selling Price, Capital Budgeting, Accelerated Depreciation

Document Summary

Get access

Related Documents

ECON 106F Lecture 8: Chapter 8

FIN 475 Lecture Notes - Lecture 3: Free Cash Flow, Capital Budgeting, Sunk Costs

FIN 300 Lecture Notes - Lecture 10: Capital Cost Allowance, Canada Revenue Agency, Capital Cost

Related Questions