CASH FLOW ESTIMATION - PowerPoint PPT Presentation

Loading...

PPT – CASH FLOW ESTIMATION PowerPoint presentation | free to view - id: 168ae6-NWFjM



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

CASH FLOW ESTIMATION

Description:

... the cash flows for a capital budgeting project, our focus is on incremental cash ... who does not have a personal interest in the project's acceptance. ... – PowerPoint PPT presentation

Number of Views:43
Avg rating:3.0/5.0
Slides: 16
Provided by: drmikecud
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: CASH FLOW ESTIMATION


1
  • Chapter 12
  • CASH FLOW ESTIMATION
  • AND RISK ANALYSIS

2
INCREMENTAL CASH FLOWS
  • When estimating the cash flows for a capital
    budgeting project, our focus is on incremental
    cash flows.
  • An incremental cash flow is how much the project
    adds to the companys total cash flows.

3
  • To make the task of estimating project cash flows
    easier, we divide the task into three segments.
  • The initial investment outlay is the difference
    in cash flow at t0
  • The annual operating cash flows are the annual
    cash profits
  • The terminal cash flow is the residual cash flow
    at the end of the project

4
Consider the Information Below for a New Project
Proposal
  • Equipment Cost is 95,000 plus 5,000
    installation
  • Working capital needs Inv20,000
    Acct.Rec5,000 Acct.Pay15,000
  • Project 130,000 in annual sales annual variable
    costs of 30 annual fixed costs of 25,000
    (years 1-3)
  • Depreciate as 3-yr MACRS property
  • Expect salvage value of 35,000 (t3)

5
  • Tax rate on additional earnings 40
  • Marketing survey cost 10,000 suggesting the new
    machines products would be well-received by
    consumers (cost has been expensed for tax
    purposes)
  • Firms cost of capital (r) is 15
  • Sales from the new project will not impact sales
    of other products

6
I. Initial Outlay (CF0)
  • The biggest component of the initial outlay is
    the equipment cost
  • If working capital must be increased, this is a
    cash outflow
  • What is this projects CF0?

7
II. Annual Operating CF (CF1-3)
  • To find the annual operating cash flows, we must
    construct an income statement for each future
    year
  • Book profit (net income) is converted to cash
    profit by adding back depreciation
  • Another name for annual cash profit is cash flow

8
III. Terminal CF (Additional CF3)
  • When the project is shut down at the end of the 3
    years, the fixed assets will be sold.
  • If the fixed assets are sold above their book
    value, the company must pay tax on the gain above
    book value.

9
III. Terminal CF (Additional CF3)
  • Working capital will be reduced back to zero, and
    the decrease in working capital will be a cash
    inflow.
  • Although the working capital may be higher or
    lower than our estimate, the default assumption
    is that the working capital will be recovered at
    original cost.

10
Project CF Summary
  • What are this projects totoal incremental (i.e.,
    relevant) cash flows?
  • If the project has a wacc of 15, the project
    should be accepted because its NPV is greater
    than zero.

11
GUIDELINES FOR ESTIMATING INCREMENTAL CASH FLOWS
  • Our analysis of the project is only as accurate
    as our future estimates of sales and costs.
    (GIGO)
  • As a practical matter, it is better to place
    someone in charge of the analysis who does not
    have a personal interest in the projects
    acceptance.

12
  • Our focus should be on cash flows rather than
    book profits because shareholder wealth is more
    closely tied to cash flow.
  • Some companies will have other noncash expenses
    besides depreciation, such as amortization or
    depletion.

13
  • Notice that we did not deduct interest expense or
    dividend payments because financing costs are
    captured in the projects wacc.
  • Notice that the cost of the marketing survey was
    omitted because it was a sunk cost a cash flow
    that is unaffected by whether the project is
    accepted or rejected.

14
  • If the project used a building that could
    otherwise have been rented out, the lost rent
    income would be treated as a cash outflow and
    viewed as an opportunity cost.
  • If sales of the new product would reduce sales of
    other products sold by the firm, the lost sales
    would be treated as a cash outflow viewed as a
    cannibalization effect or externality.

15
PROJECT RISK CONSIDERATIONS
  • If the projects risk is considered above average
    for the company, then we should increase the
    wacc.
  • One way to examine risk is to try different
    possible sales prices for our project and observe
    the NPV each produces. This is referred to as
    sensitivity analysis.
About PowerShow.com