FIN303 CHAPTER 10 REVIEW
FIN303 CHAPTER 10 REVIEW FIN303
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Giulia Dias Roncoletta
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This 4 page Class Notes was uploaded by Giulia Dias Roncoletta on Thursday February 11, 2016. The Class Notes belongs to FIN303 at University of Miami taught by Douglas R. Emery in Winter 2016. Since its upload, it has received 28 views. For similar materials see Corporate Finance Management in Finance at University of Miami.
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Date Created: 02/11/16
CHAPTER 10 10.1 AN OVERVIEW OF ESTIMATING CASH FLOWS Capital Budgeting Cash Flows: 5 Basic Concepts : (1) cost and beneﬁts are measured in terms of CF - not income (2) cash ﬂow timing is CRITICAL. money is worth more the sooner u get it (3) CF must be measured on an incremental, or marginal basis - only future expenditures and revenues are relevant to decision (4) expected future cash ﬂow is measured in an after tax basis (net gain) (5) Financing costs are not explicitly identiﬁed - the discount rate includes in it the opportunity cost for ﬁnancing the project 10.2 CALCULATING INCREMENTAL CASH FLOWS 4 categories of CF: (1) net initial investment outlay (2) expected future net operating cash ﬂow (3) non operating CF to support the project (4) Net salvage value, after-tax total amount of cash received and/or spent when project ends. (1) Net Initial Outlay: - broken-down into cash expenditures for the new capital assets, changes in net working capital, cash ﬂow from sales of old equipment, tax impact on sale of equipment. (1) cash paid for new assets = - I (2) Increase in net working capital = - W (3) cash received on sale of old equip = S (salvage value) (4) Tax paid (saved) on sale of ^ = - T(S-B) NET CF for I I = - I - W + S - T(S-B) - An increase in working capital is the difference between the additional short term assets required minutes the additional short term liabilities generated. - Working capital is the money you need initially to get things going, but will serve as a base for your proﬁt, and be returned at the end of the project. - Increase in working capital are outﬂows - Decrease in working capital are inﬂows - difference is the time value money cost of using the working capital during the project’s life. Tax Considerations: Two important considerations: (1) are assets being expensed or capitalized (2) tax consequences of selling Capitalizing: recording the outlay as an asset, and allocating (depreciating) the cost over future time periods. It leads to depreciation expense, allocates costs of assets to 2 or more periods. Expensed: Cash expenditures that are immediately recognized for tax purposes. Do not have any subsequent tax consequences, earliest recognized, earliest taxed. - ﬁrms wish they could expense every asset, but due to tax purposes, some assets are required to be capitalized. Whatever you can expense, do. Investment Tax Credit: credit again taxes due based on new capital investments Net Operating Cash Flow: Net Operating CF (CFAT) = R - E - T( R - E - D) R = change in periodic revenue E = change in periodic cash operating expense D = change in depreciation (1) ﬁnd cash ﬂow as operating cash ﬂows after tax plus the deprecation tax shield (2) ﬁnd he cash ﬂow as net income plus depreciation Non operating CF: CFs not associated with operations, can occur are various points during the project. - expensed non-operating cf, are adjusted to tac by being multiplied by (1-T) Net Salvage Value: Net salvage value: is the after-tax net cash ﬂow from terminating the project. 4 parts - sales of asset, taxes owed or saved, cleanup/removal expenses(REX), realize of net working capital Tax Liability: T(S-B) - clean up/removal expenses (REX), are expensed, therefore taxed immediately (1 -T) - net working capital is not adjusted to taxes - added cash ﬂow (1) cash received on sale = S (2) tax paid (saved) = - T(S-B) (3) AT clean up/removal = - (1 - T)REX (4) Release of W/C = W Net Salvage Value = S - T(S - B) - (1 - T)REX + W Salvage Value = S - REX 10.3AN EXAMPLE OF INCREMENTAL CASH FLOW ANALYSIS - Pre-tax operating savings = change in expenses. (negative) - Erosion when the sales of a new product reduce the sales of an existing product - Enhancement is when an interaction among products causes the increase in value 10.4 INFLATION - Expectations of inﬂation affect required returns. - Present value depends on required return and expected cash ﬂows. If any of this change, at least one more should change with it. Normal Terms: when an estimate includes inﬂation Real Terms: when inﬂation is excluded - match the required return to the cash ﬂows - discount nominal at nominal required return, and discount real at real return rr= real required return rn= nominal required return i = inﬂation (1+r ) = (1+r )(1+i) n r n = rr+ i + rr 10.5 A LITTLE MORE ABOUT TAXES - a ﬁrms should use the depreciation method that provides the largest present value of depreciation tax credits. - MACRS vs STRAIGHT LINE Depreciation 10.6 EVALUATING REPLACEMENT CYCLES Replacement Cycle: Replacement Cycle: is a routine patterns that allows the machines to be up to date with technology and be replaced when the time comes. Equivalent Annual Cost (EAC): is the equivalent cost per year of owning an asset over its entire life. - 2 step application of TVM (1) calculate present value of all costs associated with asset throughout its life - purchasing price, maintenance costs, operating costs, (2) Net initial outlay be C0 and the yearly CFAT costs be C1, C2…Cn, where n is length of assets life. - smaller the EAC, the better the investment, that means the annual cost of the machine is lower. - EAC measures the replacement frequency as well Equivalent Annual Annuities: Equivalent Annual Annuity: is a useful measure for indeﬁnitely long projects, it’s an annualized amount. - use same equations as EAC and TC, but replace: EAC = EEA TC = NPV
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