cash flow vs. accounting income

1 Cash Flow vs. Accounting Income

Project Income Statement

Revenues

- Depreciation (D)

- All other costs

EBT

- Taxes

Project NI (PNI)

Cash flow = PNI + Noncash expenses

= PNI + Depreciation

2 Cash Flow Time Line

0 1 2 3 4

CF0 OCF1 OCF2 OCF3 OCF4

Initial +

Cash Outlay Terminal

Cash Flow

NCF0 NCF1 NCF2 NCF3 NCF4

Distinguish among:

1. Initial cash outlay.

2. Operating cash flows.

3. Terminal cash flow.

3Data on 4 Period Expansion Project

n: 4 YearsSales Revenues: $60,000,000 per year starting 2007Variable Costs: 70% of sales per yearFixed Costs: $8,000,000 per yearBuilding: $12,000,000 in 2006Depreciation: MACRS - 392010 Mrkt Value: $7,500,000Equipment: $8,000,000 in 2006Depreciation: MACRS - 52010 Mrkt Value: $2,000,000Net Working

Capital (NWC): $6,000,000Tax: 40%Cost of Capital

(WACC): 12%

4BQC Expansion Project ($000s)

Building ($12,000)

Equipment (8,000)

Increase in NWC (6,000)

Total Investment ($26,000)

5BQC Expansion Project ($000s) 2006 2007 2008 2009 2010

Sales Revenues $60,000 $60,000 $60,000 $60,000

Variable costs (70% of sales) 42,000 42,000 42,000 42,000

Fixed costs 8,000 8,000 8,000 8,000

Depreciation (building) 156 312 312 312

Depreciation (equipment) 1,600 2,560 1,520 960

EBT $8,244 $7,128 $8,168 $8,728

Taxes (40%) 3,298 2851 3,267 3,491

Net Income $4,946 $4,277 $4,901 $5,237

Add back depreciation 1756 2872 1832 1272

Cash flow from operations 6,702 7,149 6,733 6,509

Return of NWC 6000

Net Salvage value 10,607

Net cash flow (26,000) 6,702 7,149 6,733 23,116

NPV (12%) 5,166 IRR=19

6Calculating Net Salvage After Tax

1) Book Value = original value - accumulated depreciation

2) Capital Gain or (Loss) = selling price - book value

3) Net Salvage Value After Tax

= selling price - capital gain tax

OR

= selling price + tax savings from book loss

Accumulated depreciation for Building = $1,092,000

Accumulated depreciation for Equipment = $6,640,000

7

1. Buy building : cash flow = ( 12,000 )

2. Buy machine : cash flow = ( 8,000 )

3. Annual tax saving from building depreciation

4. Annual tax saving from machine

5. Annual income after tax

6. NWC

7. Salvage in year 2010

8

Accounting Depreciation( Building ) = 1,092

Accounting Depreciation( Equipment ) = 6,640

Book value(Building) = 12,000 - 1,092 = 10,908

Book value (Eqipment)=8,000 - 6,640 = 1,360

9BQC Expansion Project

Year 1 2 3 4

Depreciation

(Building) 1.3% 2.6% 2.6% 2.6%

Depreciation

(Equipment) 20.0% 32.0% 19.0% 12.0%

10Time line of consolidated cash flows

(000’s)

2006 2007 2008 2009 2010

-26,000 6,702 7,149 6,733 23,116

Payback period: 3.23 Years

IRR: 19.3% versus a 12% cost of capital

MIRR: 17.2% versus a 12% cost of capital

NPV: $5,166

11Net Salvage Values

Total cash flow from salvage value = $8,863,200 + $1,744,000 =$10,607,200

Building Equipment Initial Cost $12,000,000 $8,000,000 2010 salvage (market)

value 7,500,000 2,000,000

2010 book value 10,908,000 1,360,000 Gain (loss) on sale (3,408,000) 640,000 Taxes (40%) (1,363,200) 256,000 Net Salvage value $8,863,200 $1,744,000

+ -

12Data on Replacement AnalysisCost of M1 (10 years ago): $7,500Expected Life: 15 yearsSalvage: 0Depreciation Method: Straight lineMarket value (today): $1,000Cost of M2 (today): $12,000Depreciation Method: MACRS- 3 yearsSalvage (at year 5): $2,000Increase in Net Working Capital:$1,000Increase in Earnings (before tax): $3,000 per

(or decrease in costs) yearTax 40%WACC 11.5%

13Replacement Analysis Worksheet

1) Investment Outlay

Cost of new equipment ($12,000)

Net Salvage of old equipment 1,600(Market value of old equipment 1,000

+Tax savings on sale of old equipment 600)

Increase in net working capital (1,000)

Total net investment ($11,400)

14Replacement AnalysisDepreciation Machine #1: 7500 / 15 = 500/year

Machine #1 Accumulated Depreciation =

10 years x 500 = 5000

1) Book Value = original value - accumulated depreciation

2500 = 7500 - 5000

2) Capital (Loss) = selling price - book value

(1500) = 1000 - 2500

3) Net Salvage Value After Tax

= selling price + tax savings from book loss

1600 = 1000 + [ 40%(1500)]

15Buy Machine #2

Before Taxes After Taxes

1) Earnings 3000 18002) Tax savings

from depreciationMACRS - 3 on 12,000 (new machine)Year % $

1 33 39602 45 54003 15 18004 7 8405 0 0

Accum depreciation = 12,000

16Replacement Analysis Worksheet2) Operating inflows over theproject’s life 0 1 2 3 4 5After-tax decrease in costs $1,800 $1,800 $1,800 $1,800 $1,800

Depreciation on new machine 3960 5400 1800 840 0

Depreciation on old machine -500 -500 -500 -500 -500

Change in depreciation 3460 4900 1300 340 (500)

Tax savings fromdepreciation (0.4 x 9)

1384 1960 520 136 (200)

Net operating cash flows 3184 3760 2320 1936 1600

3) Terminal year cash flows

Estimated salvage value ofnew machine

2000

Tax on salvage value (800)

Return of net working capital 1000

Total termination cash flows $2,200

4) Net cash flows

Total net cash flows ($11,400) $3,184 $3,760 $2,320 $1,936 $3,800

+

17Replacement Analysis

5) ResultsPayback period: 4.1 years

IRR: 10.1% versus an 11.5% cost of capital

MIRR: 10.7% versus an 11.5% cost of capital

NPV: -$388.77

18 Capital Budgeting Illustration

I. Data on Proposed New Asset

MACRS class: 3-year

Economic life: 4 years

Price: $200,000

Freight & installation: $40,000

Salvage value: $25,000

Effect on NWC: Increase inventories by $25,000 &

increase A/P by $5,000

Revenues: $200,000/year (100,000 units at $2/unit)

Costs (excluding depreciation): 60% of sales

Tax rate: 40%

Cost of capital: 10%

19 Capital Budgeting Illustration

II. Net Investment Outlay (t=0)

Price ($200,000)

Freight & Installation (40,000)

Increase in NWC (20,000) (25,000 - 5,000)

Net outlay ($260,000)

20

Annual Cash Flows (in ‘000)Year 0 1 2 3 4

Total revenues $200.0 $200.0 $200.0 $200.0

Operating costs

exclude depreciation (60%) 120.0 120.0 120.0 120.0

Depreciation (next slide) 79.2 108.0 36.0 16.8

Total costs $199.2 $228.0 $156.0 $136.8

EBT $ 0.8 ($ 28.0) $ 44.0 $ 63.2

Taxes (40%) 0.3 (11.2) 17.6 25.3

Net income $ 0.5 ($ 16.8) $ 26.4 $ 37.9

Depreciation 79.2 108.0 36.0 16.8

Net operating cash flows $ 79.7 $ 91.2 $ 62.4 $ 54.7

Equipment cost ($200)

Installation (40)

Increase in NWC (20)

Salvage value 25

Tax on salvage value (10)

Return of NWC 20

Net cash flows ($260.0) $ 79.7 $ 91.2 $ 62.4 $ 89.7

NPV = -$4.0 < $0 Discuss effects of:

IRR = 9.3% < k Do not accept project. 1. Sunk costs

MIRR = 9.6% < k 2. Opportunity costs

Payback= 3.3 years 3. Externalities