Anıl Sural - Cash Flow Analysis

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Anıl Sural - Cash Flow Analysis

  1. 1. 1
  2. 2. Shrieves Casting Company is considering adding a new line to its product mix and the capital budgeting analysis is being conducted. The production line would be set up in usued space in Shrieves’ main plant. The machinery’s invoice price would be approximately $220,000, another $10,000 in shipping charges would be required, and it would cost an additional $30,000 to install the equipment. The machinery has an economic life of 4 years and the accelerated depreciation rates are as follows: Year 1: 33%,.Year 2: 45%, Year 3: 15%, Year 4: 7%. The machinery is expected to have a salvage value of $50,000 after 4 years of use. The new line would generate incremental sales of 1,500 units per year for 4 years at an incremental cost of $100 per unit in the first year, excluding depreciation. Each unit can be sold for $200 in the first year. The sales price and cost are expected to increase by 5% per year due to inflation. Further, to handle the new line, the firm’s net working capital would have to increase by an amount equal to 20% of sales revenues. The firm’s tax rate is 40%, and its overall weighted average cost of capital is 10%. 2
  3. 3. A. What is the machinery’s depreciable cost basis ?What are the annual depreciation expenses ? Depreciation Basis: Cost + Shipping + Installation Basis = Cost ( $220,000) + Shipping ( $10,000) + Installation ( $30,000) = $260,000 3
  4. 4. What are the annual depreciation expenses ?Annual Depreciation Expense Year % (Inıtıal Basis) =Depreciation 1 33% * $260,000 $85.8 2 45% * $260,000 $117 3 15% * $260,000 $39 4 7% * $260,000 $18.2 4
  5. 5. B. Calculate the annual sales revenues and costs.Annual Sales and Costs ( 5% inflation is assumed ) Year 1 Year 2 Year 3 Year 4Units Quantity 1500 1500 1500 1500Unit Selling price $200 $210 $220,5 $231,52Unit Cost $100 $105 $110,25 $115,76Sales $300000 $315000 $330750 $347280Costs $150000 $157500 $165375 $173640Revenue $150000 $157500 $165375 $173640 5
  6. 6. Why is it important to include inflation whenestimating revenues and costs ?  Nominal r > real r. The cost of capital, r, includes a premium for inflation.  Nominal CF > real CF. This is because inflation.  If you discount real CF with the higher nominal r, then your NPV estimate would be too low.  Nominal CF should be discounted with nominal r and real CF should be discountes with real r.  It is more realistic to find the nominal CF than it is to reduce the nominal r to a real r. 6
  7. 7. C. Calculate the annual operating cash flows of theinvestment Year 1 Year 2 Year 3 Year 4Sales $300,000 $315,000 $330,750 $347,280Cost $150,000 $157,500 $165,375 $173,640Deprec. $85,800 $117,000 $39,000 $18,200EBIT $64,200 $40,500 $126,375 $155,440Taxes(40%) $25,680 $16,200 $50,500 $62,176EBIT(1-T) $38,520 $24,300 $75,825 $93,264+Deprec. $85,800 $117,000 $39,000 $18,200Net Op. CF $124,320 $141,300 $114,825 $111,464 7
  8. 8. D. Estimate the required net working capital for eachyearNet Working Capital For Each YearYear Sales NWC (%20) CF Due To Inv. In NWC•0 - 60,000 -60,000•1 300,000 63,000 -3000•2 315,000 66,150 -3150•3 330,750 69,456 -3300•4 347,280 0 -69,456 8
  9. 9. E. Calculate the after-tax salvage cash flowSalvage Cash FlowSalvage Value 50,000Book Value 0Gain 50,000Tax on SV(0.4) 20,000Net Terminal Cash Flow 30,000 9
  10. 10. F. Calculating net cash flows and NVP Year 0 Year 1 Year 2 Year 3 Year 4 Initial Cost -$300,000 0 0 0 0 Operational CF 0 $124,320 $141,300 $114,825 $111,464 NWC CF -$60,000 -$3,000 -$3,150 -$3,300 -$69,456 Salvage CF 0 0 0 0 $30,000 Net Cash Flow -$320,000 $121,320 $138,150 $111,525 $72,008 0 1 2 3 4 NPV = $37,437 > $0-$320,000 $121,320 $138,150 $111,525 $72,008 10
  11. 11. ANY QUESTION?THANKS FOR YOUR ATTENTION! 11

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