chapter 9 slides (1)
TRANSCRIPT
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BU 926GA
Survey of Finance
Spring 2015Chapter 9
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Key Concepts an S!i""s
Understand how to determine the relevantcash flows for a proposed investment
Understand how to analyze a projectsprojected cash flows
Understand how to evaluate an estimatedNPV
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#e"evant Cash F"o$s
The cash flows that should be included in a capital
budgeting analysis are those that will only occur if theproject is accepted
These cash flows are called incremental cash flows
The stand-alone principleallows us to analyze eachproject in isolation from the firm simply by focusing onincremental cash flows thin! of each project as a
"minifirm#
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As!ing the #ight %uestion&
Fining 'ncre(enta" Cash F"o$s $ou should always as! yourself "%ill this cash
flow change &N'$ if we accept the project(# )f the answer is "yes*# it should be included in the
analysis because it is incremental
)f the answer is "no*# it should not be included inthe analysis because it is not affected by theproject
)f the answer is "part of it*# then we should includethe part that occurs because of the project
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Co((on )ypes of Cash F"o$s
Sun! costs costs that have accrued in the past
+hould be e,cluded from cash flows
*pportunity costs costs of lost options )nclude in the cash flows* use fair mar!et value price
Sie effects
Positive side effects benefits to other projects Negative side effects costs to other projects "erosion#
Changes in net $or!ing capita"
Financing costs
-o not include interest and dividend payments onlyinterested in .ash /lows from 0ssets
)a+es 0lways loo!ing at after ta, cash flows
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,ro For(a State(ents an Cash F"o$
.apital budgeting relies heavily on pro forma
accounting statements* particularly incomestatements
.omputing cash flows refresher &perating .ash /low 1&./2 3 45)T 6 depreciation ta,es
&./ 3 Net income 6 depreciation when there is nointerest e,pense
.ash /low /rom 0ssets 1.//02 3 &./ net capitalspending 1N.+2 changes in N%.
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-e$ ,rouct .aunch / +a(p"e
7odification to current machine
3 89:*:::* ; $ear 'ife 4,pected +ales of < a unit
0nnual fi,ed .ost of 8?>*:::
+traight 'ine -epreciation
Ta, @ate 3 ;=A
8>:! in Net %or!ing .apitalNeeded
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,ro For(a 'nco(e State(ent
+ales 1::*:::
Variable .osts 18>>:
Net )ncome 8 >?*EF:
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,roecte )ota" Cash F"o$s
$ear
: ? > ;
&./ 8
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a!ing the 3ecision
Now that we have the cash flows* we can
apply the techniHues that we learned inchapter F
Should we accept or reject the project?
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ore on -4C
%hy do we have to consider changes in
N%. separately( D00P reHuires that sales be recorded on the income
statement when made* not when cash is received
D00P also reHuires that we record cost of goods sold
when the corresponding sales are made* regardlessof when we actually pay our suppliers
+o* cash flow timing differences e,ist between thepurchase of inventory* revenue and costs from its saleon the income statement* and the actual cashcollection from its sale
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3epreciation
The depreciation e,pense used for capitalbudgeting should be the depreciationschedule reHuired by the )@+ for ta, purposes
-epreciation itself is a nonGcash e,penseI
conseHuently* it is only relevant because itaffects ta,es
-epreciation ta, shield 3 -,T
- 3 depreciation e,pense T 3 marginal ta, rate
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Co(puting 3epreciation
+traightGline depreciation - 3 1)nitial cost salvage2 C number of years Very few assets are depreciated straightGline for ta,
purposes
70.@+ Need to !now which asset class is appropriate for ta,
purposes
7ultiply percentage given in table by the initial cost
-epreciate to zero 7idGyear convention
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+a(p"e 3epreciation an After/)a+ Sa"vage
$ou purchase eHuipment for 8?::*::: and it
costs 8?:*::: to have it delivered andinstalledB 5ased on past information* youbelieve that you can sell the eHuipment for
8?E*::: when you are done with it in J yearsBThe companys marginal ta, rate is =:AB%hat is the depreciation e,pense each year*and the after ta, salvage in year J* for each
of the following situations(
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+a(p"e Straight/"ine 3epreciation
+uppose the appropriate depreciationschedule is straightGline - 3 18??:*::: ?E*:::2 C J 3 8?
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+a(p"e )hree/year AC#S
$ear 70.@+
percent
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? B;;;; B;;;;1??:*:::2 3;J*JJ;
> B==== B====1??:*:::2 3
=F*FF=
; B?=F> B?=F>1??:*:::2 3?J*;:>
= B:E=? B:E=?1??:*:::2 3F*?
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+a(p"e Seven/ear AC#S
$ear 70.@+
Percent
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? B?=>9 B?=>91??:*:::2 3? B>==9 B>==91??:*:::2 3>J*9;9
; B?E=9 B?E=91??:*:::2 3?9*>;9
= B?>=9 B?>=91??:*:::2 3?;*E;9
< B:F9; B:F9;1??:*:::2 3 9*F>;
J B:F9; B:F9;1??:*:::2 3 9*F>;
5V in year J 3??:*::: ?J*9;9 ?9*>;9 ?;*E;9 9*F>; 9*F>; 3 ?=*E?F
0fterGta, salvage 3?E*::: G B=1?E*:::
?=*E?F2 3
?J*:FEB>:
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After )a+ Sa"vage
)f the salvage value is different from the boo!
value of the asset* then there is a ta, effect
5oo! value 3 initial cost accumulated
depreciation
0fter ta, salvage 3 salvage T1salvage boo!value2
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+a(p"e #ep"ace(ent ,ro7"e(
&riginal 7achine )nitial cost 3 ?::*::: 0nnual depreciation 3
9*:::
Purchased < years ago
5oo! Value 3
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#ep"ace(ent ,ro7"e( 8 Co(puting Cash F"o$s
@emember that we are interested in incremental
cash flows
)f we buy the new machine* then we will sell the
old machine
%hat are the cash flow conseHuences of sellingthe old machine today instead of in < years(
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#ep"ace(ent ,ro7"e( 8 ,ro For(a 'nco(e State(ents
$ear ? > ; = F*E;? ;
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#ep"ace(ent ,ro7"e( 8 'ncre(enta" -et Capita"
Spening
$ear :
.ost of new machine 3 8?
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#ep"ace(ent ,ro7"e( 8 Cash F"o$ Fro( Assets
$ear : ? > ; = J*=::
N.+ GF9*::: G?:*:::
)nN%.
: :
.//0 GF9*::: =J*;9F ;:*F=J ?J*=::
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#ep"ace(ent ,ro7"e( 8 Ana"ying the Cash F"o$s
Now that we have the cash flows* we can
compute the NPV and )@@ 4nter the cash flows
.ompute NPV 3 89
.ompute )@@ 3 ;JB>EA
Should the company replace theequipment?
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va"uating -,: sti(ates
The NPV estimates are just that
estimates
0 positive NPV is a good start now weneed to ta!e a closer loo!
/orecasting ris! how sensitive is our NPVto changes in the cash flow estimatesI themore sensitive* the greater the forecasting
ris! +ources of value why does this project
create value(
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Scenario Ana"ysis
%hat happens to the NPV under differentcash flows scenarios(
0t the very least* loo! atK 5est case revenues are high and costs are low
%orst case revenues are low and costs are high 7easure of the range of possible outcomes
5est case and worst case are not
necessarily probableI they can still bepossible
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Sensitivity Ana"ysis
%hat happens to NPV when we vary onevariable at a time
This is a subset of scenario analysis where weare loo!ing at the effect of specific variableson NPV
The greater the volatility in NPV in relation toa specific variable* the larger the forecastingris! associated with that variable and the
more attention we want to pay to itsestimation
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-e$ ,roect +a(p"e
.onsider the project discussed in thete,t
The initial cost is 8>::*::: and theproject has a A* and the ta,rate is ;=A
The base case NPV is 8?
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Su((ary of Scenario Ana"ysis
+cenario Net)ncome
.ash/low
NPV )@@
5ase case 8?9*F:: 8
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Su((ary of Sensitivity Ana"ysis
+cenario Unit
+ales
.ash /low NPV )@@
5ase case J*::: 8
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a!ing A 3ecision
5eware "Paralysis of 0nalysis#
0t some point* you have to ma!e a decision
)f the majority of your scenarios have positiveNPVs* then you can feel reasonably
comfortable about accepting the project )f you have a crucial variable that leads to anegative NPV with a small change in theestimates* then you may want to forgo the
project
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anageria" *ptions
.apital budgeting projects often provide
other options that we have not yetconsidered
.ontingency planning
&ption to e,pand &ption to abandon
&ption to wait
+trategic options
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Capita" #ationing
.apital rationing occurs when a firm or
division has limited resources +oft rationing the limited resources are
temporary* often selfGimposed
Lard rationing capital will never be availablefor this project
The profitability inde, is a useful tool when
faced with soft rationing
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;o(e$or!
ProblemsK ?* >* =* J* E* 9* M ?:
The 70.@+ table is on pgB >EE table 9BE
Landout Problem