MFIN1021 Chapter Notes - Chapter 9: Tax Shield, Cash Flow, Macrs
11 Jun 2018
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Chapter 9
Formulas:
Incremental cash flow: cash flow with project- cash flow without project.
Total Cash Flows: cash flows from capital investments+ CF from operating+ CF from
change in working capital.
Depreciation tax shield: tax rate * deprecation
3 formulas for CF from operations:
1. OCF= revenues- Cash expenses – taxes
2. OCF= after-tax profit + Deprecation
3. OCF= (Revenues- cash expenses)* (1-tax rate) + (tax rate * deprecation)
Gain on sale of equipment: Salvage value- tax gains
Definitions:
Opportunity cost: Benefit or cash flow forgone as a result of an action
Net working capital: Current assets- Current Liabilities
Depreciation tax shield: reduction in taxes attributed to deprecation.
straight-line depreciation: Constant depreciation for each year of the asset’s accounting life.
modified accelerated cost recovery system (MACRS): Depreciation method that allows higher
tax deductions in early years and lower deductions later.
Cash Flows:
4 steps to discounting cash flows: book than Connor McGrath
Step 1. Forecast the project cash flows. Guess how much you will get back
Step 2. Estimate the opportunity cost of capital—that is, the rate of return that your
shareholders could expect to earn if they invested their money in the capital market. Guess
what your OCC is.
Step 3. Use the opportunity cost of capital to discount the future cash flows. The project’s
present value (PV) is equal to the sum of the discounted future cash flows. Discount the
CF by your OCC and add them together
Step 4. Net present value (NPV) measures whether the project is worth more than it costs.
To calculate NPV, you need to subtract the required investment from the present value of
the future payoffs: NPV = PV - required investment.
After adding together the discounted CF at OCC, subtract the initial investment(not
adjusted for OCC)
Rules for Chapter nine:
1. When calculating NPV, recognize investment expenditures when they occur, not later
when they show up as depreciation. Projects are financially attractive because of the cash
they generate, either for distribution to shareholders or for reinvestment in the firm.
Therefore, the focus of capital budgeting must be on cash flow, not profits.
2. Include all indirect effects: To forecast incremental cash flow, you must trace out all
indirect effects of accepting the project.
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Document Summary
Incremental cash flow: cash flow with project- cash flow without project. Total cash flows: cash flows from capital investments+ cf from operating+ cf from change in working capital. 3 formulas for cf from operations: ocf= revenues- cash expenses taxes, ocf= after-tax profit + deprecation, ocf= (revenues- cash expenses)* (1-tax rate) + (tax rate * deprecation) Gain on sale of equipment: salvage value- tax gains. Opportunity cost: benefit or cash flow forgone as a result of an action. 4 steps to discounting cash flows: book than connor mcgrath. Estimate the opportunity cost of capital that is, the rate of return that your shareholders could expect to earn if they invested their money in the capital market. Use the opportunity cost of capital to discount the future cash flows. The project"s present value (pv) is equal to the sum of the discounted future cash flows. Cf by your occ and add them together.
