10-0 making capital investment decisions chapter 10 copyright © 2013 by the mcgraw-hill companies,...
DESCRIPTION
Relevant Cash Flows Incremental cash flows: cash flows that will only occur if the project is accepted. - Opportunity Costs - Side Effects - Change in NWC - Taxes 2TRANSCRIPT
10-1
Making Capital Investment Decisions
Chapter 10
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter Outline
• Relevant and Irrelevant Cash Flows• How to Evaluate a Project• Capital Budgeting Example • Special Types of Projects
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Relevant Cash Flows
• Incremental cash flows: cash flows that will only occur if the project is accepted.- Opportunity Costs- Side Effects- Change in NWC- Taxes
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Irrelevant Cash Flows
• Sunk costs • Financing costs
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How to Evaluate a Project
• 1. Calculate the Pro Forma Income Statements
• 2. Compute CF from AssetsCash Flow From Assets = OCF – net capital spending – changes in NWC where:operating cash flow (OCF) = EBIT + depr – taxesnet capital spending includes: - initial investment + after tax salvage value at the end change in NWC: always adds up to 0
• 3. Apply the Evaluation Criteria NPV, IRR, etc. 5
Capital Budgeting Example• Project X
you expect to sell 500 stereo amplifiers in year 1 at $8,000 each, unit sales grow at 10% per year variable cost = $5,000/unit fixed costs = $610,000/year Initial investment = $1,100,000 (use straight line depreciation) The project has a 4-year life In 4 years the equipment sells for $550,000 The initial investment in NWC = $900,000 Tax rate = 34%
• If the required rate of return = 20%, should you accept the project? 6
Special Types of Projects• Cost Cutting
evaluate: after-tax cost saving + depreciation tax shield instead of OCF
• Setting the Bid Price
find the OCF that sets the NPV = 0, then find the NI, sales, and finally the unit price
• Equivalent Annual Cost (EAC)use for evaluating projects of different economic livesEAC=PMT in an annuity where the PV is the NPV of the projects CFs
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