Transcript Chapter 12

Chapter 12
McGraw-Hill/Irwin
Estimating Cash Flows on
Capital Budgeting Projects
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.1
Introduction
• Proforma analysis
– Process of estimating expected cash flows of
project
– Uses relevant parts of the balance sheet and
income statements
12-2
Sample Project
Description
• Outlines relevant data to consider
• Identifies incremental cash flows directly
attributable to new project adoption
12-3
Cash Flow Estimation
• Incremental cash flows
– Cash flow changes that a new project causes
throughout the firm
12-4
Opportunity Costs
• Allocation of firm’s resources represent lost
opportunities
– Charge the project for assets used, wages
and benefits
12-5
Sunk Costs
• An expense or obligation the firm is
compelled to pay regardless of whether a
project is undertaken
– Never counted in project cash flows
12-6
Substitutionary and
Complementary Effects
• Reductions or increases necessary to
produce new products that are included in
project cash flows
– Sales
– Costs
– Necessary assets
12-7
Total Project Cash Flow
• Calculate
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Depreciation
Operating Cash Flow
Changes in Gross Fixed Assets
Net Working Capital
12-8
Depreciation
• Depreciable basis outlined in IRS Publication
946
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Cost
Amounts paid such as sales tax
Freight charges
Installation and testing fees
12-9
Depreciation
• Straight-line method
12-10
Operating Cash Flow
Operating Cash Flow (OCF) = EBIT – Taxes + Depreciation
12-11
Gross Fixed Asset Changes
• Almost always change at beginning and end
of project
– At beginning, equals asset’s depreciable
basis
– At end, must consider tax consequences of
sale
12-12
Gross Fixed Asset Changes
• After-tax cash flow (ATCF) from sale of an
asset:
12-13
Net Working Capital Changes
• Use if project has steady sales or changes in
NWC do not affect it
– Add NWC at project beginning and reduce at
end
12-14
Net Working Capital Changes
• Typical product unit sales follow bell-shaped
curve
– Changes in levels of NWC throughout the
project’s life are what need to be financed,
not the levels themselves
12-15
Accelerated Depreciation and HalfYear Convention
• IRS requires depreciation calculation using
half-year convention
– Property assumed to be placed in service at
midpoint of the period
12-16
Straight-Line Depreciation with HalfYear Convention
12-17
MACRS Depreciation
• Accelerated depreciation
– Firms receive more depreciation earlier in
asset’s life
– Double-declining-balance method
• Results in double the depreciation rate used in
straight-line
12-18
Section 179 Deductions
• Assets can be expensed immediately
– Up to $500,000* of property placed in service
each year
• Targeted at helping small businesses
*In 2010 and 2011
12-19
Special Cases are Not That
Special
• Incremental Free Cash Flow (FCF) can be
used to calculate total project costs for many
project types
12-20
Alternative Assets with Differing
Lives (EAC)
• Situations where two different assets can be
used for same purpose
– Requires restructuring each of the
incremental cash flows associated with the
assets for comparison
12-21
Flotation Costs
• Can adjust project’s initial cash flow to reflect
flotation costs as well as investment in
assets
12-22
Flotation Cost Calculation
• Compute weighted-average flotation cost
using target capital weights
• Compute flotation-adjusted initial investment
12-23