Chapter 14 Notes

65 views2 pages
Published on 1 Jun 2011
School
UTSC
Department
Finance
Course
MGFB10H3
Professor
Chapter 14 Cash Flow Estimation and Capital Budgeting Decisions Notes
14.1 General Guidelines for Capital Expenditure Analysis
marginal or incremental cash flows additional cash flows that result from budgeting decisions, generated by new projects
sunk costs costs that have already been incurred, cannot be recovered, and should not influence current decisions
opportunity costs cash flows that must be forgone as a result of an investment decision
externalities the consequences that result from an investment that may benefit or harm unrelated third parties
14.2 Estimating and Discounting Cash Flows
The Initial After-Tax Cash Flow (CF
0
)
initial after-tax cash flow (CF
0
) the total cash outlay required to initiate an investment project, including the change in net
working capital and associated opportunity costs, which may affect the firm’s cash flow, but cannot be expensed for tax purposes
capital cost (C
0
) all costs incurred to make an investment operational, such as machinery installation expenses, land-clearing
costs, and so on; these can be depreciated for tax purposes; different from initial after-tax cash flow
CF0 = C
0
+ NWC
0
+ OC
Expected Annual After-Tax Cash Flows (CF
t
)
expected annual after-tax cash flows (CF
t
) the cash flows that are estimated to occur as a result of the investment decision,
comprising the associated expected incremental increase in after-tax operating income and any incremental tax savings (or
additional taxes paid) that result from the initial investment outlay
Two Ways to Determine Cash Flows after Capital Cost Allowance
Before-tax operating income (before depreciation)
CCA
Taxable Income
Taxes payable
After-tax income
+ CCA (non-cash expense)
Net cash flow
Before-tax operating income (before depreciation)
Taxes payable on operating income
After-tax operating income
+ CCA tax savings
Net cash flow
CF
t
= CFBT
t
(1 T) + CCA
t
(T) where CFBT
t
= cash flow before taxes (i.e., incremental pre-tax operating income),
CCA
t
= the CCA expense for year t, T = the firm’s marginal (or effective) tax rate
Ending (or Terminal) After-Tax Cash Flows (ECF
n
)
ending (or terminal) after-tax cash flow (ECF
n
) the total cash flow that is generated in the terminal year of a project, aside
from that year’s expected after-tax cash flow; the estimated salvage value of the asset
salvage value (SV
n
) the estimated sale price of an asset at the end of its useful life
ECF (with Tax Implications)
n
= SV
n
+ NWC
n
[(SV
n
C
0
) × T] [(SV
n
UCC
n
) × T]
generally, capital gains are rare for depreciable capital assets because most large firms will have several assets in a given CCA
pool, and the pool will remain open after the asset is sold—as a result, the asset cost and UCC will usually be greater than the
salvage value of any particular asset, so capital gains, terminal losses, and CCA recapture will not happen
ECF
n
= SV
n
+ NWC
n
14.3 Sensitivity to Inputs
Sensitivity Analysis
sensitivity analysis examination of how investment’s NPV changes as value of different inputs are changed, one input at time
this type of analysis allows firms to determine which of their estimates are the most critical in the final decision
obviously, the most critical estimates require the greatest amount of scrutiny from the firm
scenario analysis analysis of how investment’s NPV changes in response to varying scenarios in terms of 1 or more estimates
it is also informative to vary the discount rate used in the NPV calculations, because this variable is hard to estimate precisely
and can change substantially through time as market, industry, and company conditions change
it often makes sense to vary more than one input variable at a time, because it allows us to account for interactions among the
variables and for the fact that many of them can related to external variables
real option valuation (ROV) assessment that recognizes firms respond to unlike circumstances and change operating features
Real Option Valuation (ROV)
ROV places great weight on the flexibility involved in a firm’s operations
decision tree a schematic way to represent alternative decisions and the possible outcomes
NPV Break-Even Analysis
www.notesolution.com
Unlock document

This preview shows half of the first page of the document.
Unlock all 2 pages and 3 million more documents.

Already have an account? Log in

Document Summary

14. 1 general guidelines for capital expenditure analysis: marginal or incremental cash flows  additional cash flows that result from budgeting decisions, generated by new projects. Two ways to determine cash flows after capital cost allowance. Cft = cfbtt (1 t) + ccat (t) Ccat = the cca expense for year t, t = the firm"s marginal (or effective) tax rate where cfbtt = cash flow before taxes (i. e. , incremental pre-tax operating income), 9: consider the effect of all project interdependencies on cash flow estimates, treat inflation consistently. This harks back to comparing like with like: discount nominal cash flows with nominal. Ignore intangible considerations. discount rates, and real cash flows with real discount rates: undertake all social investments required by law, estimate the future cash flows associated with potential investments. These cash flows include 3 categories: initial cash flow, the expected annual after-tax cash flows, and the ending cash flow. o o o.