Chapter 11: Cash Flows & Other Topics in Capital Budgeting 2000, Prentice Hall, Inc.
CHAPTER 12 Cash Flows and Other Topics in Capital Budgeting
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Transcript of CHAPTER 12 Cash Flows and Other Topics in Capital Budgeting
CHAPTER 12CHAPTER 12
Cash Flows and Other Topics Cash Flows and Other Topics in Capital Budgetingin Capital Budgeting
Time line for Solution Practice Problem 2Time line for Solution Practice Problem 2
Cash FlowsCash Flows
0 1$197,500
2$197,500
3$197,500
4$197,500
5$197,500
8$158,400+$41,400 =$199,800
6$158,400
7$158,400
TerminalCash flow
Annual Cash Flows
Initialoutlay$590,000
Automation ProjectAutomation Project:: Cost of equipment = Cost of equipment = $550,000$550,000.. Shipping & installation will be Shipping & installation will be $25,000$25,000.. $15,000$15,000 in net working capital required at setup. in net working capital required at setup. 8-year project life, 5-year class life.8-year project life, 5-year class life. Simplified straight line depreciation.Simplified straight line depreciation. Current operating expenses are Current operating expenses are $640,000$640,000 per yr. per yr. New operating expenses will be New operating expenses will be $400,000$400,000 per yr. per yr. Already paid consultant Already paid consultant $25,000$25,000 for analysis. for analysis. Salvage value after year 8 is Salvage value after year 8 is $40,000$40,000.. Cost of capital = Cost of capital = 14%,14%, marginal tax rate = marginal tax rate = 34%34%..
Problem 2Problem 2
Problem 2 Problem 2
Initial OutlayInitial Outlay::
(550,000)(550,000) Cost of new machineCost of new machine
+ (+ (25,00025,000)) Shipping & Shipping & installationinstallation
(575,000)(575,000) Depreciable assetDepreciable asset
+ (+ (15,000)15,000) NWC investmentNWC investment
(590,000)(590,000) Net Initial OutlayNet Initial Outlay
240,000 240,000 Cost decreaseCost decrease
((115,000115,000) ) Depreciation increaseDepreciation increase
125,000125,000 EBITEBIT
((42,50042,500)) Taxes (34%)Taxes (34%)
82,50082,500 EATEAT
115,000115,000 Depreciation reversalDepreciation reversal
197,500 = Annual Cash Flow 197,500 = Annual Cash Flow
For Years 1 - 5:For Years 1 - 5: Problem 2
CALCULATION OF ANNUAL CALCULATION OF ANNUAL DEPRECIATION FOR NEW MACHINE:DEPRECIATION FOR NEW MACHINE:
Depreciable asset/class life =$575,000/5 yrsDepreciable asset/class life =$575,000/5 yrs
= $115,000= $115,000
The machine is used only for 5 years. From The machine is used only for 5 years. From years 6-10, no depreciation; therefore years 6-10, no depreciation; therefore depreciation will be $0 for these last 5 years. depreciation will be $0 for these last 5 years.
240,000 240,000 Cost decreaseCost decrease
( 0)( 0) Depreciation increaseDepreciation increase
240,000240,000 EBITEBIT
(81,600)(81,600) Taxes (34%)Taxes (34%)
158,400158,400 EATEAT
00 Depreciation reversalDepreciation reversal
158,400 = Annual Cash Flow 158,400 = Annual Cash Flow
For Years 6 - 8:For Years 6 - 8:Problem 2
Terminal Cash FlowTerminal Cash Flow::
40,000 Salvage value40,000 Salvage value
(13,600) Tax on capital gain(13,600) Tax on capital gain
15,000 15,000 Recapture of NWC Recapture of NWC
41,400 Terminal Cash Flow41,400 Terminal Cash Flow
Problem 2
CALCULATION OF TERMINAL CASH FLOWCALCULATION OF TERMINAL CASH FLOW
Annual depreciation of new machine=$115,000 Annual depreciation of new machine=$115,000
(from slide 7)(from slide 7)
Book valueBook value = Depreciable asset – Total = Depreciable asset – Total amount depreciated amount depreciated
= $575,000 - $115,000(5yrs)= $575,000 - $115,000(5yrs)
= $0= $0
Capital gain Capital gain = Salvage value-Book Value= Salvage value-Book Value
= $40,000-$0 = $40,000= $40,000-$0 = $40,000
Tax on capital gain Tax on capital gain = 34% x $40,000= 34% x $40,000
= $13,600 (refer slide 8)= $13,600 (refer slide 8)
Problem 2 SolutionProblem 2 Solution
NPV and IRR:NPV and IRR: CF(year 0) CF(year 0) = -$590,000 (slide 4)= -$590,000 (slide 4) CF(years 1 - 5) CF(years 1 - 5) =$197,500 (slide 5)=$197,500 (slide 5) CF(years 6 - 7) CF(years 6 - 7) = $158,400 (slide 7)= $158,400 (slide 7) CF(year 8) CF(year 8) = $158,400 + $41,400 = $158,400 + $41,400
= $199,800 (slides 7 + 8)= $199,800 (slides 7 + 8) Discount rate = 14%.Discount rate = 14%. IRR = 28.13% IRR = 28.13% NPV = $293,543NPV = $293,543.. We would We would acceptaccept the project. the project.
FINDING NPV-FINDING NPV-11stst method (annuity + individual CF) method (annuity + individual CF)
NPVNPV = -$590,000 = -$590,000 (year 0) (year 0)
+ $197,500 (PVIFA 14%, years 1-5)+ $197,500 (PVIFA 14%, years 1-5) (years 1-5)(years 1-5)
+ $158,400 (PVIF 14%, 6+ $158,400 (PVIF 14%, 6thth yr) yr) (year 6)(year 6)
+ $158,400 (PVIF 14%, 7+ $158,400 (PVIF 14%, 7thth yr) yr) (year 7) (year 7)
+ $199,800 (PVIF 14%, 8+ $199,800 (PVIF 14%, 8thth yr) yr) (year 8)(year 8)
= -$590,000 = -$590,000
+ $197,500(3.4331)+ $197,500(3.4331)
+ $158,400 ( (0.4556)+ $158,400 ( (0.4556)
+ $158,400 ( (0.3996)+ $158,400 ( (0.3996)
+ $199,800 (0.3506)+ $199,800 (0.3506)
= -$590,000 +$678,037 +$72,167 +$63,297 +$70,050= -$590,000 +$678,037 +$72,167 +$63,297 +$70,050
= -$590,000 +$883,551 = = -$590,000 +$883,551 = $293,551$293,551
Accept the project since NPV is positive.Accept the project since NPV is positive.
FINDING NPV-FINDING NPV-22ndnd method (annuities) method (annuities)
NPVNPV = -$590,000 = -$590,000 (year 0) (year 0)
+ $197,500 (PVIFA + $197,500 (PVIFA 14%, 5years14%, 5years)) (years 1-5)(years 1-5)
+ $158,400 (PVIFA + $158,400 (PVIFA 14%, 2 years,6&7) 14%, 2 years,6&7)
(PVIF 14%, 5)(PVIF 14%, 5) (annuities years 6-7)(bring back to (annuities years 6-7)(bring back to time 0). time 0). Refer Refer to TVM ppt, slides 68-71 for to TVM ppt, slides 68-71 for understanding.understanding.
+ $199,800 (PVIF + $199,800 (PVIF 14%,1014%,10thth year year) ) (year 8)(year 8)
= -$590,000 = -$590,000
+ $197,500(3.4331)+ $197,500(3.4331)
+ $158,400 (1.6467)(0.5194)+ $158,400 (1.6467)(0.5194)
+ $199,800 (0.3506)+ $199,800 (0.3506)
= -$590,000 +$678,037 +$135,479 +$70,050= -$590,000 +$678,037 +$135,479 +$70,050
= -$590,000 +$883,556 = -$590,000 +$883,556 = $293,566 = $293,566
Accept the project since NPV is positive.Accept the project since NPV is positive.