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Ch10   measuring cash flow Ch10 measuring cash flow Document Transcript

  • Chapter 10MEASURINGCASH FLOW Alex Tajirian
  • Capital Budgeting CFs 10-2 1 OBJECTIVE# We already know criteria for selecting projects (payback, NPV, IRR). What are the relevant CFs in the analysis of capital budgeting?# What is involved in calculating NPV? ! # of CF periods (this chapter) ! amount of CFs (this chapter) ! risk of use of CF# Accounting vs. Financial/Economic ValuationL Still assume that “k” (cost of financing) is given. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-32 WHAT ARE A PROJECT’S CFs?2.1 Basics incremental / additional The only relevant CFs for a project are incremental CFs. They consist of any and all changes in the firm’s future CFs that are a direct consequence of taking the project. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-42.2 A CLOSER LOOK AT INCREMENTAL CFs2.2.1 INCLUDE OPERATING OPPORTUNITY COST! Definition: CF generated from assets the firm already owns. Distinguish this from financing opportunity cost-- "k".! Example: Opportunity Cost Suppose company already has extra storage space. Is storage cost for the project = 0? No, you have to include storage cost, as if you had to go and rent space for the particular project.! Financial accounting does not consider opportunity cost.? Should cost be estimated as the market value or purchase price? © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-52.2.2 INCLUDE NET WORKING CAPITAL (NWC)# Definition: NWC = current assets - current liabilities = C/A - C/L# Why include NWC? ! Projects usually require investment in A/R and inventory as sales _. ! Investment in C/A is recoverable at end of project as A/R is collected and inventory sold.Example: Incremental CFs due to change in NWC Given the following info from Income Statement: A/R Jan 95 A/R Dec 95 $50 $80 CF = ? Solution: 80 - 50 = 30 $30 is cash outflow; as if firm is lending $30. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-62.2.3 Operating Cash Flow (OCF)# Definitions ! Revenue = R = (price of product)(Quantity sold) ! Operating Cost = C = fixed cost + variable cost fixed cost = overhead variable cost1 = salaries, employee benefits, unsold defective products, etc. Example: Sales 1994 Sales 1995 Incremental CFs in 1995 $120 $200 ? = $200 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-72.2.4 FORGET ABOUT SUNK COSTS# Definition: Costs that cannot be recovered# Illustrations ! marketing expenditure ! existing railroad tracks ! You spent $2,000 on your old Moscovich car yesterday. Suppose it broke down again today and it would cost you $2,500 to re-fix. If your car was in running condition, it would be worth $2,200. The junkyard would only pay you $200. Repair or scrap? The $2,000 you spent on the original repair is irrelevant (sunk cost).# Financial accounting does not consider sunk cost. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-82.2.5 CONSIDER IMPACT ON THE ENTIRE FIRM. side effects / spillovers/ externalities ! Effect on other parts (divisions/projects) of the firm Q negative (cannibalization) e.g., The introduction of a new software version Q positive (network effects) e.g., Make your “system” compatible with others. ! General Example: Project Impact on Entire Firm You own a jazzercise enterprise for women. If you include men, you will obtain new source of revenue. Should you undertake the project? New proposal can _ or ` in women patronage.2.2.6 CONSIDER POTENTIAL OF CREATING NEW PRODUCTS IN THE FUTURE Note: This is easier said than done. Easy methods to incorporate these effects are not available yet. They involve game theory and option pricing. However, this does not mean that you should ignore them! © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-92.2.7 INTEREST EXPENSE NOT INCLUDED AS CF ! Cost of financing is reflected in the process of discounting the CFs -- k. ! Obviously the higher the cost of financing, the higher the k. Thus, the lower the PV. ! That is why it is possible to separate the investment and the financing decisions. ! In practice, firms calculate NPV as if there will be no debt financing, then decide on how to best finance the project. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-103 SPECIAL APPLICATIONS: REPLACEMENT & PURCHASE OF NEW ASSETS3.1 INVESTMENT-RELATED OUTLAYS# Initial (t = 0) ! investment in plant & equipment (I0) ! After-tax value of sale of equipment in asset-replacement problem.# Terminal (time = end of project) ! After-tax salvage or sale value of plant and equipment at end of project3.2 CHANGES IN NET WORKING CAPITAL (NWC); short-term# Definition NWC = Current Assets - Current Liabilities NWC = C/A - C/L ) NWC = ) C/A - ) C/L ) / change in / additional / incremental change in © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-113.3 Operating Cash Flow (OCF)# Approach 1 OCF = Revenue - Operating Cost - Tax Bill = R - C - (tax rate) ( R - C - Depreciation) . . . . . . .(*) = ® - C) - T ® - C) + T x D = ® - C) (1 - T) + T x D = (Revenue - Operating Cost)(1 - tax rate) + (tax rate) x (Depreciation) = after-tax profits + depreciation tax shield © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-12# Approach 2 From equation (*) above OCF = ® - C) - T® - C - D) = ® - C) - T® - C - D) + (D - D) = ® - C - D) - T® - C - D) + D = EBIT (1 - T) + Depreciation where, EBIT = Earnings Before Interest & Taxesˆ OCF R & C & Tax bill (R & C)(1 & T) % T × Depreciation EBIT × (1 & T) % Depreciation © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-13 Putting all the above components together, we have,CF OCF & ) NWC & I Operating CF & change in Net Working Capital & Inital outlays cash inflow & cash outflow Notes. ! ) NWC > 0 means cash outflow. ! _ in investment outlays is cash outflow. ! Cost of financing a project is not included as a CF. It is reflected in the cost of capital (k). ! if CL _ Y a cash in-flow ! You subtract ) NWC because an _ in NWC is a cash-outflow --short-term investment. Obviously, I is also subtracted --long- term cash outflow. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-14Example: Two Approaches to Calculating OCFGiven: tax rate = T = 40% Project Income Statement Revenue $100 Depreciation (D) 20 All other operating costs 40 EBIT 40Solution:# Approach 1 OCF = ® - C)(1 - T) +(T)(Depreciation) OCF = ($100 - $40) (.6) + (.4) ($20) = $36 + $ 8 = 44# Approach 2 OCF = EBIT(1 - T) + Depreciation OCF = $40 ( 1 - .4) + 20 = 40 (.6) + 20 = 24 + 20 = 44 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-15Example: Two Approaches to CF CalculationGiven: For simplicity, assume depreciation = T = 0, capital spending = 0. R = $500, C = $310, and A/R, A/P are given below. Y only two sources of CFs # first source: OCF OCF = ® - C)(1 - T) + Tax x Depreciation = (500 - 310)(1 - 0) + 0 = 190 # second source: ) NWC Given ? Beginning End Change A/R $880 $910 30 A/P 550 605 55 NWC 330 305 -25 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-16Solution: Two approaches # CF = OCF - ) NWC - capital spending = 190 - (-25) - 0 = 215 # Solution based on cash in- and outflows: cash inflow = Sales - ) A/R = 500 - 30 = 470 cash outflow = Cost - ) A/P = 310 - 55 = 255 Net CF = 215 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-174 HOW MANY YEARS SHOULD YOU USE?# In practice, this is very hard to determine. Strategic considerations are very important. (FI 320)# Depends on Economic Life of asset in consideration. The government sets depreciation schedule. Obviously, if salvage value after being fully depreciated is zero, then economic life = years of depreciation.# For this class: ! economic life / useful life / # of years of CFs generated by project ! You will be given this number. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-18 5 UN-EQUAL LIVES PROBLEM.5.1 IllustrationYou are planning to spend 4 years in Moscow and need to own a car forthe entire duration. After some search, you have narrowed down yourchoices to a Ferrari and a Moscovich. The latter is expected to last onlytwo years. The CFs from the two cars are below. Which car would youbuy? Net Cash Flow Year Moscovich Ferrari 0 ($100,000) ($100,000) 1 60,000 33,500 2 60,000 33,500 3 0 33,500 4 0 33,500Solution with no finance background: at k = 10%, NPVMoscovich = $4,130 NPVFerrari = -$100,000 + $33,500 (PVIFA10%,4) = $6,191Approach is © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-195.2 Solutions to Un-equal Lives Problem: un-equal lives ] one of the projects is generating CFs over longer time horizon and you need CFs over the entire time Y need to re- purchase short-life asset in the future.5.2.1 Solution 1:# Project Moscovich: ! Since the project provides CFs over only 2 years, you need to re-purchase another car after two years. ! Assume that cost of re-purchase and CFs do not change. 0 1 2 3 4 CFs from first -100,000 60,000 60,000 purchase CFs from -100,000 60,000 60,000 re-purchase Net CFs -100,000 60,000 -40,000 60,000 60,000 Using above CFs, k = 10% NPVMoscovich = 7,547# From previous calculation: NPVFerrari = 6,190ˆ choose Moscovich, since higher NPV © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-205.2.2 Solution 2: Equivalent Annual Annuity (EAA) Method is based on continuous replacement (re-purchase). This technique is used to simplify the problem of having to make lives equal. Original NPV EAA PVIFAk,original life $4,132 $4,132 EAAMoscovich $2,381 PVIFA10%,2 1.7355 6,190 6,190 EAAFerrari $1,953 PVIFA10%,4 3.1699 ˆ choose one with highest EAA. Y Ferrari = © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-21 6 ACCOUNTING vs. FINANCIAL VALUATION! Accounting ignores CF timing, risk, and operating opportunity cost.! Also, earnings or income are not good measures of performance as accounting numbers can be manipulated. An example would be changing from LIFO to FIFO.Illustration Revenue 510 Cost 310 Net Income 200 Beginning End Change AR 880 1,390 510 AP 0 0 0 ˆ Cash inflow = Revenue - )AR = 510 - 510 =0 Cash outflow = Cost - )AP = 310 - 0 = 310 Net CF = 0 - 310 = - 310 Thus, although the division is making money in an accounting sense (earnings), it is not in an economic sense. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-227 EXAMPLE: PURCHASE OF A NEW ASSETGiven: Data on Proposed New Asset MACRS depreciation 3-year Economic life 4 years Price $100,000 Freight & Installation $20,000 Salvage Value $30,000 in year 4 Effect on NWC Increase inventories by $10,000 Effect on operating costs Decrease by $50,000 per year Tax rate 40% Project cost of capital 10% © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-23Solution: periods 0 1 2 ... N Initial initial Outlay outlays OCF OCF - - )NWC )NWC Terminal Outlays Terminal Outlays net CFs net CFsStep 1: Calculate initial Outlay (t=0) Price ($100,000) Freight & installation (20,000) ) NWC (10,000) Net initial outlay (130,000) © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-24Example: Purchase Of Asset (Continued)Step 2: Calculate Depreciation1 Schedule (MACRS) Net cost = price + freight & installation = $120,000 Given Need to Calculate Year Factor Depreciation = Book Value = (factor)(Net cost) Net cost - Total Depreciation 2 1 33% 39,600 120,000 - 39,600 2 45 54,000 120,000 - (39,600 + 54,000) 3 15 18,000 ... 4 7 8,400 0 $120,000 1 Depreciation factors depend on the appropriate depreciation schedule. They are givenAppendix. Depreciation includes all costs incurred to bring the purchased asset to an operationalcondition. 2 (33%) x ($120,000) © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-25Step 3: Calculate # of periods: n = 4 years, since economic life = 4, and sold in year 4.Step 4: Calculate CF = - Initial Outlays + (OCF - )NWC) - Terminal Outlays © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-26Example: Purchase Of Asset (Continued) periods 0 1 2 3 4 initial outlay (130,000) (R-C)(1-T) 30,000 030,000 30,000 0 30,000 (Tax) x (Depreciation) 15,840 21,600 7,200 3,360 OCF 45,840 51,600 37,200 33,360 Salvage value 30,000 tax on salvage value (12,000) NWC recovery 10,000 Net CF (130,000) 45,840 51,600 37,200 61,360 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-27Step 5: Calculate NPV 45,840 51,600 61,360NPV & 130,000 % % % ... % (1% .1) (1% .1)2 (1% .1)4 & 130,000 % 45,850×[PVIF10%,1] % ... % 61,360×[PVIF10%,4] = $24,176; IRR = 18.1%Note: (R-C)(1-T) = (0 - (- $50,000))(1-.4) = $30,000 Tax x Depreciation = .4(39,600) = $15,840 in year 1 Salvage Value Tax = (Salvage Value - Book Value) (T) = (30,000 - 0) (.4) = $12,000Remember to distinguish between the different costs: 7 ! investment costs (long-term) ! operating costs (OCF) ! cost of capital (k) ! NWC costs © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-28 8 Endnotes1.Varies with the quantity of output produced. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-29 9 QUESTIONSI. True/False-Explain1 A NPV > 0 project might end up with NPV < 0 if external financing were to be used.2 An increase in inventories is a cash outflow.3 Suppose company X has AR=$90 at the end of 1991. Thus, AR CF is necessarily $90.4 Quayle Potatos Inc. is a one man "cash and carry business." If revenues are > operating expenses, the firm should stay in business.5 An increase in inventory is a cost to the firm. So is an increase in operating costs. Thus, there is no compelling reason to distinguish between these two costs. Costs are costs!6 If the government increases depreciation allowance, it should have no impact on the value of a firm since depreciation is not a cash flow.7 NPV analysis can be easily applied by managers of the newly "emerging democracies."8 It does not make sense to use NPV in project analysis, since you never really know how long you would be using the machine.9 The source of project finance is irrelevant because it has no impact on a projects CFs.10 An increase in NWC is a cash outflow.11 If the acquisition of a new computer reduces the cost of inventory tracking, then undertaking the project would decrease NWC, other things equal.12 If sales (# of items sold) from a project increase over time, then it makes sense to anticipate a corresponding increase in NWC.13 If a projects Revenue increases from $50 to $60, then cash inflows necessarily increase by $10.14 If a project were to be financed by issuing new equity, then floatation cost have to be included as part of the project CFs. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-30II. NumericalThe purpose of the numerical questions is to ensure that: a. you understand the different types of costs and how they influence valuation. b. What is and is not a CF. c. you know how to correctly substitute in the NPV equation.1. Machine Purchase You are interested in the purchase of a machine that costs $100,000. The machine has an economic life of 4 years, with 3-year MACRS depreciation. However, you expect to sell it after 3 years at a salvage value of $8,000. The machine requires an increase in inventory by $10,000. While in operation, the machine will generate $10,000 annually and it would cost $2,000 to operate. If the corporate tax rate is 40%, and k = 20%, should the machine be purchased?2. Machine Replacement You are considering the replacement of an existing machine that has been fully depreciated. It can be sold for $10,000. The cost of the new machine is $100,000.The machine has an economic life of 4 years, with 3-year MACRS depreciation. However, you expect to sell it after 3 years at a salvage value of $8,000. The machine requires an increase in inventory by $10,000. While in operation, the machine will generate $10,000 in revenue annually and it would cost $2,000 to operate. If the corporate tax rate is 40%, and k = 20%, should the machine be replaced?3.H Machine Replacement You bought a machine 4 years ago at $100,000 that is being depreciated straight line over its 5- year life. The machine has a salvage value of $30,000. You are now considering its replacement with a new $110,000 machine, which would reduce annual operating costs from $60,000 to $25,000. The new machine, which requires an additional $10,000 in modification costs, has an economic life of 3 years and would be straight line depreciated. On a time line write down the relevant CFs for the replacement analysis, assuming a 40% tax rate. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-314. Given the following end-of-period information (in $000s) on a project, write down the relevant annual CFs. 1989 1990 1991 1992 Cost of machine 14 Machine Modification Costs 1 1 Revenue 10 20 40 Operating Cost 5 10 15 Inventory 1 2 2 Depreciation 8 5 2 Tax rate (40%)5. Due to difficult economic conditions, a clothing store is considering some cost cuttings. Their current annual sales are at $1m., operating costs at $700,000, and inventory at $100,000. The owners proposal for the next 3 years is to cut inventory in half and reduce operating costs by $25,000. Due to cutbacks, they expect to lose 30% of their sales. The owners are at a 30% average tax rate. (a) You were hired as a consultant for the project. Given the above scenario provided to you, would you recommend the proposal? (b) Can you come up with a better proposal? © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-32 ANSWERS TO QUESTIONSI. Agree/Disagree-Explain1. Disagree. When you calculate NPV you better use the appropriate cost of capital. In this case, it looks like you used the wrong number and ended up with project NPV > 0.2. Agree. An increase in inventories is a short-term investment. Thus, a cash-outflow.3. Disagree. We should look at incremental cash flow, that is the difference between AR at end of 1991 and beginning of 1991.4. Disagree. Whoever is doing the analysis is forgetting to include the owners salary--opportunity cost. If you include opportunity cost, then NPV might turn out to be negative.5. Disagree. The reason for the distinction is in calculating tax CF. NWC does not influence the tax bill, while operating costs do.6. Disagree. Although depreciation is not a CF, it enters into the calculation of OCF through the tax bill the firm has to pay. Thus, depreciation _Ytax bill ` Y CF_ Y NPV_.7. Disagree. Although NPV is still very useful, the difficulty lies in estimating CFs and the discount rate. With no financial markets, it is very difficult to determine the required rates of return that we take for granted in the U.S.8. Disagree. It does make sense. The number of years you use in the analysis is the best estimate you have. As we shall see in the next chapter, you can analyze different scenarios.9. Disagree. Although it does not affect the CFs, it does impact the NPV calculation through to cost of capital (k). Thus, it is relevant.10. Agree. An increase in NWC is a short-term investment. Thus, it is a cash outflow.11. Disagree. Inventory tracking costs are part of operating costs. Thus, NWC would not be affected.12. Agree. When sales increase, the firm has to incur additional AR and inventory. Although AP might increase too, such an increase need not be enough to offset the increase in CA. Thus, NWC tends to increase.13. Disagree. When Revenue increases, it is usually accompanied by an increase in AR. Thus, The © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-33 statement would only be Agree if the corresponding ) AR = 0.14. Disagree. Floatation costs are paid to an investment banker for assisting in the issuing and sale of a new securities. These are part of the financing cost, not OCF. Thus, they are not included. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-34II. Problems.1. Machine PurchaseStep 1: Calculate Initial outlays (t = 0) Outlays Cash Flow price ($100,000) Freight & installation 0 ) NWC (10,000) Sale of old machine 0 Tax on sale of old machine 0 Net initial outlays -110,000Step 2: Calculate OCFs Step 2A: Depreciation of new machine year Factor Depreciation Book Value 1 0.33 33,000 67,000 2 0.45 45,000 22,000 3 0.15 15,000 7,000 4 0.07 7,000 0 100,000 Depreciation = (amount depreciated)(factor) = ($100,000) (factor) Book Value = un-depreciated amount © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-35 Step 2B: Calculate OCF (t = 3) t= 1 t=2 t=3 t=4 Revenue 10,000 10,000 10,000 0 Cost 2,000 2,000 2,000 0 T 0.4 0.4 0.4 0.4 (R-C)(1-T) 4,800 4,800 4,800 0 (Tax) x (Depreciation) 13,200 18,000 6,000 0 OCF 18,000 22,800 10,800 0Step 3: Calculate Terminal outlays Terminal outlays Cash Flow Salvage Value (SV) 8,000 Tax on Salvage† (400) NWC Recovery 10,000 Total 17,600† Tax on Salvage value = ( SV - Book Value )(T) = (8,000 - 7,000)(.4) = $400 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-36Step 4: Calculate Net Cash Flows t=0 t=1 t= 2 t= 3 Initial (110,000) outlays OCF 18,000 22,800 10,800 Terminal 17,600 outlays Net CF (110,000.00) 18,000.00 22,800.00 28,400.00Step 5: Calculate NPV 18,000 22,800 28,400 NPV & 110,000 % % % (1% .2) (1% .2)2 (1% .2)3Using a calculator or spreadsheet ....IRR = © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-37Problem 2. Machine ReplacementStep 1: Calculate Initial outlays (t = 0) price ($100,000) Freight & installation 0 ) NWC (10,000) Sale of old machine 10,000 Tax on sale of old machine (4,000) Net initial outlays (104,000) Note: Since the machine has already been depreciated, there is no change in future tax CFs due to differences in tax shield.Step 2: Calculate OCFs Identical to problem 1Step 3: Calculate Terminal outlays Identical to problem 1 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-38Step 4: Calculate Net Cash Flows t=0 t=1 t= 2 t= 3 Initial (104,000) outlays OCF 18,000 22,800 10,800 Terminal 17,600 outlays Net CF (104,000) 18,000 22,800 28,400Step 5: Calculate NPV 18,000 22,800 28,400 NPV & 104,000 % % % (1% .2) (1% .2)2 (1% .2)3Using a calculator or spreadsheet, IRR = © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-393) All numbers are in (000)Depreciationold machine = $20, Depreciationnew machine = $40 = (110 + 10)/3Cost Saving = $60 - $25 = $35 t=0 t=1 t=2 t=3 cost of new -110 machine cost of -10 modification Sale of old 30 machine Tax impact of sale -(30-20)(.4) (R-C)(1-T) (35)(.6)† (35)(.6) (35)(.6) Tax x (40-20)(.4)‡ (40)(.4) (40)(.4) Depreciation terminal outlays 0 Net CF -94 29 37 37 † (R-C)(1-T) = (0-(-35))(1-.4) = 21 ‡ Since the old machine is not fully depreciated, the incremental Depreciation = (new machine depreciation - old machine depreciation) = (40 - 20) = 20 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-404)Step 1: Calculate Incremental CFs 1989 1990 1991 1992 Cost of machine 14 Machine Modification 1 1 Costs Revenue 10 20 40 Operating Cost 5 10 15 Inventory 1 1 0 Depreciation 8 5 2Step 2: Calculate Net CFs 1989 1990 1991 1992 Investment Outlays 15 1 (R - C)(1-T) (10-5)(.6) (20-10)(.6) (40-15)(.6) Tax x Depreciation (.4)(8) (.4)(5) (.4)(2) NWC 1 1 0 NWC recovery 2 © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-415a. (in 000) (R - C)(1 - T) = [-300 - (-25)](1-.3)= (-275)(.7) = -192.5 )NWC = -50 Net CF = OCF - )NWC = -192.5 - (-50) = - $142.5No, since all Net CFs < 0. © morevalue.com, 1997 Alex Tajirian
  • Capital Budgeting CFs 10-42 ELIMINATIONS4. An important factor in whether the government should support a non-defense industry, is the existence of positive spillover to other industries or sectors.4. Agree. Without spillover, the country would be undertaking negative NPV projects. With the spillover, you would be creating other positive NPV projects that would outweigh any negative ones. However, the difficulty is in determining industries with potential spillover and measuring the amount of such spillover.554. © morevalue.com, 1997 Alex Tajirian