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1. Cash Flow Estimation
and Other Topics in
Capital Budgeting
By Group 4

2. .
.
.
.
(C1C022079)
M Nabil Ibrahim
Kinanti Nindia
Dwi Ananda
Members of Group 4 :
Alya Dwi
Fitriyati
Rizka Dwi Putri
(C1C022149) (C1C022082)
(C1C022101)
.
M Rifki Yumas
Saputra
(C1C022166)

3. Estimating Cash
Flow
The most important and most difficult step in capital budgeting is
estimating the project's cash flows-investment expenditures and
annual net cash inflows once the project is underway.

4. Identifying Relevant Cash Flows
Capital budgeting decisions should be based
on cash flows, not accounting earnings
Only incremental cash flows are relevant to
the accept/reject decision
The first step in cash flow estimation is to identify the relevant cash flows, defined as the
specific set of cash flows that should be considered in making a decision. Mistakes often
occur:

5. In capital budgeting, the difference between cash flow
and accounting profit is critical. Accounting profit
reflects the return on invested capital, while cash flow is
the money that is actually available. For example,
accounting profit may increase due to a decrease in
depreciation, but actual cash flow may decrease. In
capital decision-making, net cash flow, which involves
adjustments for non-cash expenses, is the main focus to
ensure the right decision.
Cash Flow Versus Accounting Profit

6. Incremental Cash Flow
Embedded Costs Opportunistic Cost
Shipping and
Installation Costs
Externality
In evaluating a project, we focus on the cash flows that occur and only if we
accept the project. These cash flows, called incremental cash flows, reflect the
change in the company's total cash flow that occurs as a direct result of accepting
the project.
4 Specific Issues in Determining Incremental Cash Flows :

7. Change In Net Working Capital
If this change is positive, as is common in
project expansions, it indicates that
additional financing beyond the fixed
asset costs will be needed to fund the
increase in current assets.

8. Terminal Year Cash
Flows
Operating Cash Flows
Over the Project's Life
Initial Investment Outlay
Evaluating Capital Budgeting Projects
Generally, the incremental cash flows from a particular project can be classified as
follows:

9. Expansion
Projects
Expansion project refers to a strategic initiative undertaken by a company to
invest in new assets or develop new products or services with the aim of
increasing sales, entering new markets, or enhancing operational capabilities.

10. Cash Flow Analysis
Initial Investment Spending
Projected Cash Flows
Recovery of Working Capital
Estimation of Residual Value

11. Risk Assumptions and
Cost of Capital
Quantitative Analysis
Conclusion
Impact of Forecasting
Errors
Qualitative Factors
Uncertainty in
Calculations
Decision-Making

12. Project
Replacement
Analysis
In replacement analysis, the decision to replace an existing asset
involves considering cash flows from the old asset and evaluating
the benefits and costs of replacing it with a new one. This involves
assessing factors like depreciation, salvage value, operating cost
changes, tax implications, and the impact on net present value. The
analysis ensures a comprehensive understanding of the financial
implications and helps make informed decisions regarding asset
replacement.

13. Awesome
words

14. Explanation
● Line 1
The top section of the table, from Row 1 to 5, explains the cash flows occurring at
(almost) t = 0, which is at the time of the investment.
● Line 2
Here, we are showing the price received from the sale of the old equipment.
● Line 3
As the old equipment will be sold below its book value, a loss will occur, reducing
the company's taxable income and consequently affecting the payment of the
next quarterly income tax.
● Line 4
The investment in additional net working capital (the new current asset
requirement minus the increase in trade debt and accruals) is shown here.

15. ● Line 5
Here, we demonstrate the total net cash outflow at the time of replacement.
● Line 6
Part II of the table displays the incremental operating cash flows or the expected
benefits if the replacement is carried out.
● Line 7
The base depreciation of the new machine at $12,000, multiplied by the MACRS
allowance for a 3-year property, yields the depreciation figure shown in Row 7.
● Line 8
Row 8 shows the straight-line depreciation of $500 for the old machine.

16. ● Line 9
The depreciation expense for the old machine shown in Row 8 might not occur if
the replacement is carried out, but the depreciation for the new machine will take
place.
● Line 10
The change in depreciation results in a tax reduction equal to the change in
depreciation multiplied by the tax rate.
● Line 11
Here, it shows the net operating cash flow over the five-year project life.
● Line 12
Part III illustrates the cash flows associated with the project's termination. To
begin with, Row 12 shows the estimated salvage value of the new machine at the
end of the project's life, which is $2,000.

17. ● Line 13
As the book value of the new machine at the end of Year 5 is zero, the company
must pay taxes of $2,000 * 0.4 = $800.
● Line 14
The investment in additional net working capital of $1,000 is shown as an outflow
at t = 0.
● Line 15
Here, it shows the total cash flow stemming from the termination of the project.
● Line 16
Part IV shows, in Row 16, the total net cash flow in a format suitable for capital
budgeting evaluation. Essentially, Row 16 represents the timeline.

18. The capital budgeting principles used in analyzing
replacement projects also apply when a company decides
whether it's advantageous to call their existing bonds and
replace them with new bonds bearing a lower coupon rate. The
evaluation involves comparing the cost of refinancing
(including call premiums and flotation costs for issuing new
bonds) against the present value of interest savings by calling
high-coupon bonds and replacing them with new bonds at a
lower coupon rate. This comparison helps determine the
financial benefit of the refinancing decision.

19. Comparing Projects With Different
Ages
What is the Replacement Chain Method?
The replacement chain method is a capital budgeting decision model
that compares two or more mutually exclusive capital proposals with
unequal lifetimes.
This methodology involves determining the number of years of cash
flow (project life span) for each project and creating a "replacement
chain," or iteration, to fill in the gaps in shorter-lived projects.

20. • The equal annual annuity approach is one of two
methods used in capital budgeting to compare mutually
exclusive projects with unequal lives.
What is the Equal Annual Annuity Approach?
• The EAA approach uses a three-step process to compare
projects. The present value of the constant annual cash
flows is exactly equal to the net present value of the
project.

21. Inflation is a condition in which the
prices of goods and services generally
increase continuously. In the context of
capital budgeting decisions,
understanding inflation is crucial as it
can significantly affect the planning and
execution of capital projects.
Inflation
Effect of Inflation on Capital Budgeting
1.Revenue and Profit Projections
2.Revenue and Profit Projections
3.Revenue and profit projections

22. Thank You!
Any questions?