Chapter 10 Incremental Cash Flow

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Chapter 10Incremental Cash Flow

• Three Financial Statements
• Fundamental Accounting Relationship
• Cash Flow Identity to Sources and Uses
• Estimating Incremental Cash Flow
• Capital Spending and Depreciation
• Disposal of Capital Equipment
• Projected Cash Flow for Project

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Three Financial Statements

• Income Statement Measure of performance over a
  specific time
• Statement of Financial Position or Balance Sheet
  Listing of all assets, liabilities, and
  ownership claims
• Sources and Uses of Cash or Statement of Cash
  Flow Where dollars came from and where dollars
  were spent

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Three Financial Statements

• Income Statement bottom line is net income
• Net income is not cash flow
• Accrual Accounting timing of cash and recording
  of economic transaction different
• Noncash items depreciation for example
• Want operating cash flow (OCF)
• Use modified income statement
• Interest expense is not part of OCF

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Three Financial Statements

• The Balance Sheet Categories
• Cash Account
• Key element is change in cash over the period
• Cash includes money, checking accounts, etc.
• Working Capital Accounts
• Current Assets and Current Liabilities
• Assets and Liabilities typically converted to
  cash or paid over the business cycle
• Long-Term Debt
• Owners Accounts
• Snapshot of company at a specific point in time

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Three Financial Statements

• Statement of Cash Flow or Sources and Uses of
  Cash
• Cash flow from business operations
• Cash flow from financing
• From Owners (residual claims)
• From Lenders (fixed claims)
• Cash flow for capital spending
• Purchase of capital equipment
• Recapture cash from sale of assets
• Ties to the change in Cash Account over the period

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Fundamental Accounting Relationship

• Accounting Identity in two forms
• Assets Liabilities Owners Equity
• Cash Flow from Assets Cash Flow to Creditors
  Cash Flow to Owners
• Building the Cash Flow Identity
• Cash Flow from Assets Operating Cash Flow
  Increases in Net Working Capital Increases in
  Capital Spending
• Work through components, pages 269-271

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Fundamental Accounting Relationship

• Continued Building the Cash Flow Identity
• Cash Flow to Creditors
• Interest paid on debt shows up in this section
  not in operating cash flow
• Any repayment of principal on debt claims
• Cash Flow to Owners
• Dividend Payments
• Any retirement of common stock
• Increases in debt or common stock are cash flow
  from owners or creditors

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Cash Flow Identity to Sources and Uses of Cash

• Once the components of the cash flow identity are
  calculated
• Convert the information into the Statement of
  Cash Flow or Sources and Uses of Cash
• The change in the cash account is the bottom
  line of this statement
• Three Categories
• Operating Activities
• Investing Activities
• Financing Activities

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Estimating Incremental Cash Flow

• Objective Estimate future cash flow of a
  project (for decision making)
• Only Incremental Cash Flow used in decision
• Sunk Costs Do not use
• Erosion Costs Must account for lost sales of
  old products when new product introduced
• Working Capital new projects require working
  capital, must include in cash flow
• Capital Expenditures Usually large up front
  cash flow out
• Depreciation and cost recovery on divesting assets

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Capital Spending and Depreciation

• Capital Spending for a project is usually an up
  front cash outflow
• It is expensed on the income statement over time
  via depreciation
• Depreciation is not a cash flow
• Deprecation impacts cash flow through reduction
  in taxes, a real cash flow
• Different Types
• Straight line depreciation
• Modified Accelerated Cost Recovery System (MACRS)

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Capital Spending and Depreciation

• Depreciation example for Cogswell Cola
• Bottling Machine Initial cost is 1,500,00
• Include installation costs, another 150,000
• Property class for MACRS is 7 years
• Annual depreciation expense
• Year 1 1,650,000 x 0.1429 235,785
• Year 2 1.650,000 x 0.2449 404,085
• Year 8 1,650,000 x 0.0445 73,425
• Table 10.7 for all eight years

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Disposal of Capital Equipment

• When a capital asset is disposed of by a company
  it can result in cash flow
• Fully depreciated assets, sale price minus taxes
  paid on gain on sale
• When asset is not fully depreciated
• Determine current book value of asset
• Difference between sales price and book value is
  the gain or loss on disposal
• Tax a gain and tax credit on a loss
• Cash flow is sales price tax or sales price
  credit
• Example 10.3 College Doughnuts Disposal

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Projected Cash Flow for Project

• Putting all the elements together on incremental
  cash flow for decision making on a project
• Initial Investment (typically capital spending
  and increases in working capital)
• Annual operating cash flow
• Disposal of equipment
• Decrease in working capital at conclusion of
  project
• Use Incremental Cash Flow with
• NPV Model
• IRR Model
• Example Bottle Water Project Table 10.12

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Problems

• Problem 1 Balance Sheet Accounts
• Problem 3 Operating Cash Flow
• Problem 5 Income Statement
• Problem 6 Cash Flow from Assets
• Problem 7 Cash Flow to Creditors
• Problem 8 Cash Flow to Owners
• Problem 9 Cash Flow Identity
• Problem 11 Erosion Costs
• Problem 15 Depreciation Costs