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ARE171B Whitney Week 1 Notes Lectures 1 and 2

by: Jessica Notetaker

ARE171B Whitney Week 1 Notes Lectures 1 and 2 ARE171B

Marketplace > University of California - Davis > Agricultural & Resource Econ > ARE171B > ARE171B Whitney Week 1 Notes Lectures 1 and 2
Jessica Notetaker
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About this Document

These notes are from March 29 and 31. I have typed up my revised notes for you to use. I hope it helps!
Financial Management
Marilyn Whitney
Class Notes
Whitney, financial, Management, are171b, notes, week1, lecure1, lecture2, spring, 2016




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This 2 page Class Notes was uploaded by Jessica Notetaker on Sunday March 27, 2016. The Class Notes belongs to ARE171B at University of California - Davis taught by Marilyn Whitney in Spring 2016. Since its upload, it has received 32 views. For similar materials see Financial Management in Agricultural & Resource Econ at University of California - Davis.

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Date Created: 03/27/16
Lecture 1 (3.29.16) Review & Overview Review 171A Concepts -­‐ The firm’s goal is to maximize stock price -­‐ Stock value: discounted sum of expected future cash flows -­‐ Find stock price with constant growth stock using the formula P=D1/(r+g) or D0(1+g)/(r-g) where “r” is investors’ required rate of return for the firm and “g” is the expected dividend growth rate -­‐ Where did “r” value come from? o One main method to solve “r” is with CAPM o Rj = Rf + Bj(RMbar-Rf) where “Rf” is risk-free rate and “(RMbar-Rf)” is market or equity risk premium o Firms invest in projects that generate series of future expected cash flows. Net present value of these expected future cash flows, evaluated at own weighted average cost of capital (WACC), gives the dollar amount added to the firm’s value from the project. o WACC = We*Re + Wps*Rps + Wd*Rd*(1-T) where “We” is equity share, “Wps” is preferred stock share, and “Wd” is debt (bond) share. -­‐ Recall the balance sheet: o The left side includes current assets and long-term assets o The right side includes current liabilities, long-term liabilities, and shareholders’ equity. o Current assets include cash, accounts receivable, and inventories o Long-term assets include real estate, plant and equipment, patents, trademarks, and goodwill o Long term liabilities include bonds Capital Budgeting Overview -­‐ Helps to figure out which long-term assets to invest in -­‐ Steps in Capital Budgeting 1. Identify potential investment projects 2. Estimate after-tax incremental operating cash flows from the project 3. Evaluate or rank proposed projects (using NPV or IRR) 4. For chosen projects, re-evaluate later to make sure actual numbers meet the estimates Generating Investment Projects Proposals -­‐ Many types of projects might increase the value of a firm. 1. Introduce new product or expand output of an existing product a. Ideas come from marketing department 2. Prepare or repair existing plant or equipment a. Arise from operations staff 3. Research and Development (R+D) a. From top management or R+D staff 4. Exploration a. Certain staff is in charge of these proposals such as engineers, geologists, etc. 5. Other a. Regulatory compliance such as OSHA standards b. Employee amenities such as cafeteria, gym, etc. Estimating Project After-tax Incremental Operating Cash Flows -­‐ “Incremental”: observe change in cash flows with vs. without the project -­‐ “Operating”: financial costs not included -­‐ “Cash flows”: net accounting profits -­‐ Basic Principles: 1. Ignore Sunk Costs 2. Include Opportunity Costs 3. Consider changes in net working capital a. Change in net working capital = change in current assets minus change in current liabilities 4. Consider inflation Lecture 2 (3.31.16) Estimating Project After-Tax Incremental Operating Cash Flows New Project -­‐ Let’s say a firm wants to open a food truck. We need to find initial cash outflow (ICO), interim cash flows, and terminal cash flow. -­‐ Assume that the truck costs $31,000 with expected life of 10 years and shipping cost $1000. At end of 10 years, salvage value is $5000. It is also in the MACRS 5-year category for depreciation purposes. Also, assume that change in net working capital is $200. Also, assume expected inflation is 4%, tax-rate T=.4, and estimated annual change in net operating revenue is $20,800. o Find ICO  31,000 (truck cost) + 1000 (shipping) + 200 (change in working capt.) = $32,200 o Find interim cash flows  Say in Year 1, depreciation basis is $31,000 and MACRS factor is .2, then depreciation is 6200  CFt = $20,800((1+inf)^(t-1))(1-T) + Deprt*T  E.g. 20,800(1+.04)^0(1-.4)+6200(.4) = 14,960 and then continue with same process until year 10 with the calculated depreciations and MACRS factor. o Find terminal cash flow  At end of useful life, truck sells for salvage value $5000 with no book value so the $5000 is a “recapture of excess depreciation”. After-tax salvage value is 5000(1-.4) = $3000. Recovering net working capital is “freed-up working capital” +200.  Terminal cash flow is 3000+200= $3,200


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