Chapter 4 Cash Flows and Planning

Why do we have things like depreciation?

• Why are managers more interested in Cash flow than profits?

• What is Operating Cash Flow?• What is Free Cash Flow?

Planning

• What is the difference between long-term and short-term financial plans?

• What is the pro forma process?

What is Depreciation• What is the depreciable basis?• I purchased an asset for $75,000. It costs $2,000 to ship the

asset to my facility and $4,000 to install. The IRS has classified this asset as a 5 year MACRS asset.

• What does the depreciation schedule look like?• Worksheet: CB Cash Flows Year Depr expense Book Value

123456

New Asset Data Depreciation of Old AssetCost $75,000 3 Yr Asset 5 Yr AssetMACRS Life 5 1 0 $16,200Installation Costs $6,000 2 0 $25,920

3 0 $15,390Old Asset Data 4 0 $9,720Original Basis $81,000 5 0 $9,720MACRS Life 5 6 0 $4,050Purchased? (ago) 0 7 0 $0Current Market Price 8 0 $0Tax RateBook Value $81,000

Example• This year I expect to have taxable income of $750,000. The asset

replaced by the asset above has two years left of $54,000 depreciable basis. What is the tax that I would expect to pay if I did not buy the new asset?

• What will be the difference in taxable income with the new asset?

• What is the new tax expected next year?

• How do you use the book value information?

900,495100,254000,750NI100,25434.*)000,335000,750(000,113Tax

742,9807,020-750,000EBT new020,7180,9200,16depr in change

491,267251,713-742,980NI new713,251.34*335,000)-(742,980113,000liability Tax

Old Asset Data 4 0 $6,480Original Basis $54,000 5 0 $6,480MACRS Life 5 6 0 $2,700Purchased? (ago) 4 7 0 $0Current Market Price 8 0 $0Tax RateBook Value $9,180

Book ValueWorking Capital 1 0 0Change in CA 2 0 0Change in CL 3 0 0Change in Working Capital $0 4 0 0

5 0 6,4806 0 2,7007 0 08 0 0

Book Value $0 $9,180Go To

Determine the free cash flowKeith Corporation Balance Sheets

Assets 2012 2011Cash and Mkt Securities 3,300 2,200Accounts Receivable 2,000 1,800Inventory 2,900 2,800 Total Current Assets 8,200 6,800Gross Fixed Assets 29,500 28,100 Acc. Depreciation 14,700 13,100 Net Fixed Assets 14,800 15,100Total Assets 23,000 21,800 Liabilities and Equity Accounts Payable 1,600 1,500Notes Payable 2,800 2,200Accruals 200 300 Total Current Liabilities 4,600 4,000Long-term Debt 5,000 5,000 Total Liabilities 9,600 9,000Common Stock 10,000 10,000Retained Earnings 3,400 2,800 Common Equity 13,400 12,800Total Liability and Equity 23,000 21,800

Keith Corporation Income Information

Depreciation 1,600

EBIT 2,700

Interest Expense 367

Dividends Paid 800

NPM 1,400

Tax Rate 40%

Use Worksheet: Free Cash Flow Calculation

Year 2012Net Income 1399.80Non-Cash Expenses $1,600 CFAT 2999.80Taxes ($) (not deferred) $933EBIT $2,700 OCF 3366.80

CA (beg) $6,800 NCAI 1400.00CA (end) (change) $8,200

NFAI 1300.00A/P and Accruals (beg) $1,800A/P and Accruals (end) (change) $1,800 FCF 666.80

Fixed Assets (beg) $15,100Fixed Assets (end) change $14,800 CF Firm 666.80OCF (if given) CF Creditors 367.00Total Equity (beg) $12,800 CF Shareholders 299.80Total Equity (end) change $13,400

Dividends $800

Total LT Debt and N/P (beg) $5,000Total LT Debt and N/P (end) change $5,000Interest Expense $367

DO Not Include N/P as a Current Liability! Assume it is long term.

Lawrence Byerly PhD © 2013

Chapter 4 Web exercise (50 points)• In Yahoo finance; Go to Competitors (10)

Who are the company’s primary competitors (name and ticker)

1)2) 3)

• How does your company compare to the competitors and the industry?

– revenues– gross margin– PE – EPS

Go to Analyst opinion (3)

• How do analysts rate the companies?• How do the analyst’s feel about this

company?• Upgrades vs Downgrades?• What is the target price? Where is

your company?

Go to Analyst Estimates (10)

• What are the next year’s estimates for –Revenue–EPS–PE (under growth estimates) How does

the company stack up against the industry and the sector?

• What does this relationship show?

Go to Basic chart

• Click the S&P index box and type in the ticker symbol for one of your company’s competitors above. Choose the big chart and the 1 year chart.

• Copy and paste chart into this word document. (5)

• How has your company’s prices moved relative to the index and the competitor? (5)

Got to Basic Chart

• Now go back and switch the chart to the 5yr chart.

• Now compare to the index and competitor. (5)

Calculate CF numbers (2 years)

• Use worksheet Free CF Calculation

• Copy and paste special the worksheet below your explanation. Type in the answers. (10)

OCF FCF CFAT

Year before

Last year

Can you explain the differences?

Exercise problems 15 points• The Laramie Company is considering the purchase of two new

machines for their production line. Create the depreciation tables for the two assets. Use the CB Cash Flow worksheet. (5 points)– Drill Press is a 7 year MACRS asset with a cost of 25,000. It will take $10,000 to install

the drill press.– Depreciable basis =– Insert table from worksheet– The fork lift is a 5 year MACRS asset, which has an installed cost of $44,000.– Insert table.

• The Zombie Express Company has an estimated pre-tax income of $750,000. They are considering purchasing a new piece of 5 year MACRS machinery that has an installed cost of $900,000. (Use the Cash Flow Calc spreadsheet) (5 points)

Questions

• What is the current tax liability prior to the purchase?

• What is the depreciation expense for year one for the purchase?

• What is the new pre-tax income after the purchase?

• What is the new tax liability?• What is the net income pre-purchase?• What is the net income post-purchase?

FCF Calculation

• Use the financial Statements on page 115 of the textbook to solve for

a) Calculate the OCFb) Calculate the FCFc) Calculate the CFAT.

• Explain the differences between the answers in a and b.