the age-adjusted mortality rate for cancer is essentially unchanged over the past half-century, at...
TRANSCRIPT
The age-adjusted mortality rate for cancer is essentially unchanged over the past half-century, at about 200 deaths per 100,000 people. This is despite President Nixon’s declaration of a “war on cancer” more than thirty years ago, which led to a dramatic increase in funding and public awareness.
Believe it or not, this flat mortality rate actually hides some good news. Over the same period, age-adjusted mortality from cardiovascular disease has plummeted, from nearly 600 people per 100,000 to well beneath 300.* What does this mean?
Many people who in previous generations would have died from heart disease are now living long enough to die from cancer instead.
Indeed, nearly 90 percent of newly diagnosed lung-cancer victims are fifty-five or older; the median age is seventy-one. The flat cancer death rate obscures another hopeful trend. For people twenty and younger, mortality has fallen by more than 50 percent, while people aged twenty to forty have seen a decline of 20 percent. These gains are real and heartening — all the more so because the incidence of cancer among those age groups has been increasing. (The reasons for this increase aren’t yet clear, but among the suspects are diet, behaviors, and environmental factors.)
Capital Budgeting and Cash Flow Analysis
This chapter discusses capital budgeting and capital expenditures.
It deals with the financial management of the assets on a firm’s balance sheet. We will be looking at management of long
term assets
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Capital Budgeting: the process of planning for purchases of assets whose returns are expected to continue beyond a year
Capital Expenditure: a cash outlay that is expected to generate a flow of future cash benefits lasting longer than one year
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Expand an existing
product line
Working capital
Refunding
Leasing
Merger and
acquisition
Enter a new line of
business
Replacement
Advertising
campaign
R&D
Education and
training
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Firm’s overall cost of funds Remember WACC is the overall CoC for a
company
The CoC is the investors’ required rate of return
Provides a basis for evaluating capital investment projects The CoC is the hurtle rate of projects
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Independent Put in candy machines and add a new parking lot
Mutually Exclusive Build a conveyor system or buy team of forklifts
Contingent Put in a drainage system but only if build a new
parking lot
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The majority of our decisions will come from Mutually Exclusive project decisions Purchase new machine
Purchase used machine
Rent machine
Repair old machine
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The best firms always have more projects than they have money
Most companies have a limited amount of dollars available for investment
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A firm should operate at the point where Marginal cost of an additional unit = marginal revenue See next slide
Invest in the most profitable projects first
Continue accepting projects as long as the rate of return exceeds the MCC
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It is not as easy as accepting projects A,B,C,D, and E
All projects may not be known at one time So you always need some free cash flow for
new projects Changing markets, technology, and
corporate strategies can make current projects obsolete and new ones profitable.
Estimates of CFs have varying degrees of uncertainty but we assume they are the same
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Step 1 Generating proposals
Step 2 Estimating CFs
Step 3 Evaluating alternatives and selecting projects
Step 4 Reviewing prior decisions
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Today's lecture will
cover
Growth opportunities Apple’s iPad
Cost reduction opportunities Ford’s new production line
Required to meet legal requirements United Steel’s pollution abatement equip
Required to meet health & safety standards Phillip Morris’s new packaging of cigarettes
Most of these project ideas come from marketing, R&D, or external 14
Once projects have been suggested and classified cash flows must be generated
This is often done in the accounting and finance departments
Estimating cash flows is very difficult and requires a knowledge of both capacity of production and estimation of revenue
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On an incremental basis How will the entire stream of CF’s for the firm be
affected if you don’t adopt the project? Called a what if
analysis
On an after-tax basis Very few projects can be undertaken with before-tax
dollars
Include indirect effects For example when Coke developed Coke Zero. What
effect did that have on Diet Coke’s revenues? 17
Exclude sunk costs
If you have already spent it then don’t count
it. Example would be survey for land
Opportunity costs of resources
If you are using a warehouse, even if it set
vacant, then it must be included in the cost of
the project
For help estimating CF’s use the following:
Small Business Association http://www.sba.gov/
American Cash Flow Institute http://acfi-online.com/
American Cash Flow Association http://acfa-cashflow.com/
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The net investment is the initial cash outlay at T0
Step 1 Cost plus installation and shippingPlus
Step 2 Increases in net working capitalMinus
Step 3 Net proceeds from sale of existing assetsPlus or minus
Step 4 Taxes associated with the above saleEquals
NINV
Remember to check out the tax consequences
Suppose the James Corp is considering replacing a dye press in it’s Texas office. The existing dye press was purchased 25 years ago for $600,000. The book value for the dye is $200,000, and James Corp feels they could sell it for $150,000. A new dye press can be purchased for $1,200,000. To deliver the dye and install it will cost an additional $100,000. Assuming the marginal tax rate for James Corp is 40%, calculate the net investment for the dye press.
Dye Cost 1,200,000 Plus Delivery and Installation 100,000 Installed cost 1,300,000 Minus Proceeds from sale of old asset 150,000 Minus Tax savings on loss from sale of old asset($50,000 x .4) 20,000 Net Investment 1,130,000
Harness Technology will spend $800,000 on a piece of equipment that will manufacture fine wire for the electronics industries. The shipping and installation charges will be $240,000 and net working capital will increase $48,000.The equipment will replace an existing machine that has a salvage value of $75,000 and a book value of $125,000. If Shunt has a current marginal tax rate of 34 percent, what is the net investment?
Wire Equipment 800,000 Plus Delivery and Installation 240,000 Installed cost 1,040,000 Plus Initial net working capital required 48,000 Minus Proceeds from sale of old asset 75,000 Minus Tax savings on loss from sale of old asset** ($125,000 - $75,000)(0.34) = $17,000 17,000 Net Investment 996,000
The NINV for a multiple-period investment is the PV of the series of outlays discounted at the firm’s cost of capital. Below example CoC = 10%
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Not only are we concerned with the cost of a project we also need to know how it will effect the firms after tax net cash flows
To do this we need to calculate the change in revenues, costs, and depreciation
See formula next slide
tNCF = (ΔR - ΔO - ΔDep)(1 - T)+ ΔDep - ΔNWC
If a salvage sale of assets occurs during year , add these terms to the end of the equation:
+ proceeds from the salvage sale ± tax effect of the salvage sale
t
t w wo w wo w woNCF = [(R -R ) - (O - O ) - (Dep -Dep )]× 1 T
w wo+(Dep -Dep ) - ΔNWC
EBITDepORNote )(:
Wabash is replacing an old, fully depreciated stamping line with a more efficient machine. With the increased production, Wabash expects revenues to increase by $155,000, operating expenses to increase by $22,000, and depreciation to increase by $21,878. Compute the net cash flow if net working capital is expected to increase by $30,000
NCF = ($155,000 - $22,000 - $ 21,878)(1 - 0.40) + ($21,878) - ($30,000) = $58,551.2
WalMart is considering expanding their current production facility. This year WalMart had an operating income (EBIT) of $760,000, interest expenses of $120,000, depreciation expenses of $45,000, and capital expenditures of $160,000. Next year, after the expansion is completed, operating income is expected to be $880,000, interest expenses will remain at $120,000, but depreciation will increase to $61,000. To support the expansion, cash is to expected to increase by $5,000, accounts receivable by $12,000, inventories by $8,000, and accounts payable by $7,000. What is the change in WalMart's net operating cash flows attributable to this project, if the tax rate is 40%?
NCF = ($880,000 - $760,000)(1 - 0.40) + ($61,000 - $45,000) - ($5,000 + $12,000 + $8,000 - $7,000) = $70,000
Remember that NWC is equal to Current assets – current liabilities
After a project is completed we oftentimes can sell the capital asset
This must be considered when calculating the NPV of a project
There are specific tax consequences to this sale
Open to page 331; next slide
Case 1 Sale = book value No tax consequences
Case 2 Sale < book value Tax savings = marginal tax rate x amount of loss
Case 3 Sale > book value Tax liability = Gain x marginal tax rate
Case 4 Sale > cost Tax liability = (Gain + capital gain) x marginal tax rate
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The management of Harness Equipment Company is planning to purchase a new milling machine that will cost $160,000 installed. The new machine will be depreciated on a straight line basis over it's 10 year economic life to an estimated salvage value of $10,000. What is the depreciation per year on a straight line basis?
= ($160,000 - $10,000)/10 = $15,000
The total amount of accumulated net working capital (current assets – current liabilities) is usually recovered at the end of the life of the project.
The resulting decrease in net working capital represents an increase in net cash flow!
There are generally no tax considerations associated with the recovery of net working capital.
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NINV NCF + NWC at end
Remember that depreciation is the systematic allocation of the cost of an asset over a period of years Two primary methods straight line and MACRS
For financial reporting to management, we can use straight-line or various accelerated depreciation methods.
For tax purposes, use the Modified Accelerated Cost Recovery System (MACRS). 37
Lets read example at bottom of page 333 Our two steps will be to calculate both
NINV NCF
A project that requires a firm to invest funds in additional assets in order to increase sales (or reduce costs)
Calculate the annual net cash flows associated with the project.
Calculating Annual Net Cash Flows
NCF1 = ($50,000 - $25,000 - $11,000) x (1 - .40)
+ $11,000 - $5,000 = $14,400
NCF2 = ($60,000 - $26,500 - $11,000) x (1 - .40)
+ $11,000 - $5,000 = $19,500
NCF5 = ($45,000 - $31,562 - $11,000) x (1 - .40)
+ $11,000 - $22,000 = $34,463
See next slide for complete breakdown
*The -22,000 includes the NWC from the NetInv
Our previous example looked at expanding a project. Now we are going to look at replacing an existing project
To do this we must: Calculate the Net Investment Calculate Annual Net Cash Flows
Lets read the case at the top of page 336
Calculating Annual Net Cash Flows NCF1 = [($85,000 - $70,000)
- ($20,000 - $40,000)- ($20,000 - $0)] x (1 - .40) + ($20,000 - $0) - $0 = $29,000
Calculating Annual Net Cash Flows NCF10 = [($103,000 - $70,000)
- ($29,000 $40,000)- ($20,000 - $0)] x (1 - .40) + ($20,000 - $0) - $0 + $25,000 salvage value- (0.4 x $25,000) tax on
salvage value= $49,400
We will learn this in the next lesson, but suppose that the WACC of Briggs & Stratton is equal to 11.25%. What would be the NPV?
Most firms depend on subjective estimates from their managers, sensitivity analysis, computer simulations, and expert opinion when forecasting cash flows.
To become more accurate at this process firms MUST compare actual and projected cash flows
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A survey of Fortune 500 firms found: The majority of the firms responding to the
survey had annual capital budgets of more than $100 million.
Nearly 67% of the firms prepared formal cash flow estimates for over 60 % of their annual capital outlays.
56% percent indicated that they used single-dollar estimates, 8% used a range of estimates, and 36% used both single-dollar estimates and a range of estimates.