Chapter 7

Capital Investments

and

Cash Flows

2

Capital Budgeting

• Generating Ideas

• Estimate the Cash Outflows and Inflows

• Evaluate the Risks

• Select Projects

• Monitor the Accepted Projects

3

Sources of Ideas

• Committees

• R&D

• Employees

• Vendors

• Competition

4

Sources of Cash Flows

• Direct Cash Flows

• Indirect Cash Flows

• Incremental Cash Flows

• Sunk Costs

5

Measuring Cash Flows

As with Most Investment:

Cash Flows Upfront

Cash Flows Along the Way

Cash Flows at End of Project

6

NICO – Net InvestmentCash Outflow (Upfront Cash Flow)

• Asset Acquisition - Investment in Depreciable Assets

• Asset Disposition - Tax Effect on Disposition

• Changes in Net Working Capital

7

Tax Effects on Asset Disposition

Dispose of Asset for More than Book Value:

Disposition price – Tax on Gain

Dispose of Asset for Less than Book Value:

Disposition price + Tax Savings on Loss

8

Annual Cash Flow Changes(Along the Way)

ΔOCF = ΔEAT + ΔDEP

ΔOCF = (ΔREV - ΔOP EXP - ΔDEP)(1 - T) + ΔDep

Depreciation

MACRS Class Life

9

MACRS Tables

10

Disposal/Terminal Cash Flows

• Asset Disposition - Tax Effect on Disposition

• Recovery of Net Working Capital