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473.32 12 Winter 2014

CF. 473.32 12 Winter 2014. Questions. What cash flows should I consider? How does the market set r ? How should I set r ?. CF 1. at CF 1 n 1 = 0. at time 0. CF 1. at time 0 at the very beginning of the project when decision to go ahead made

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473.32 12 Winter 2014

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  1. CF 473.32 12 Winter 2014

  2. Questions • What cash flows should I consider? • How does the market set r? • How should I set r?

  3. CF1 at CF1n1= 0 • at time 0

  4. CF1 • at time 0 • at the very beginning of the project • when decision to go ahead made • any costs incurred to make decision ignored • when added all together • almost always < $0

  5. CF1 • at time 0 • includes • capital cost • usually equipment • shipping, installation, training, etc. • everything needed to get it up & running • working capital • cash • flotation costs start-up costs

  6. CF1 • at time 0 • also includes • present value of Capital Cost Allowance • minus the CCA of salvage revenue • PVCCA tax shield • PV of getting working capital back • PVworking capital

  7. CF1

  8. CF1 start-up costs weighted average flotation cost fa

  9. Flotation Costs • issuing new stocks or bonds isn’t free • weighted average flotation cost debt equity 2/1 1/1 1/2 2 1 .5 fd=2% fe=5% wd=.67 wd=.50 wd=.33 we=.33 we=.50 we=.67

  10. Flotation Costs • issuing new stocks or bonds isn’t free • weighted average flotation cost • use target weights • over the long term, firm will issue securities in these percentages

  11. Flotation Costs • project • firm’s target D/E ratio is .6 • flotation costs • 5% equity • 3% debt

  12. Flotation Costs

  13. Flotation Costs

  14. you get the cash (working capital) back at end of project what’s that refund worth to you today?

  15. CCA tax shield • tCCACCA tax shield rate • tc corporate tax rate • rdiscount rate • s salvage value • n number of periods in the project

  16. “hurdle rate”

  17. CF1

  18. Productivity • considering • new production system • initial cost $1 million • save $300,000/yr • in inventory & receivables management costs • last for 5 years • CCA tax shield rate of 20% • salvage value of $50,000 • no impact on Net Working Capital • marginal tax rate is 40% • required return is 8%.

  19. Productivity

  20. Applications • cost-cutting proposals • replacing an asset • setting a bid price • comparing equipment with different lifespans

  21. CCA tax rate 20% salvage $0 tax rate 40% discount rate 10% Cost-Cutting Proposal • equip • $80,000 • to buy & install • save • $35,000 • pretax • lifespan • 5 years • NWC • $0

  22. Cost-Cutting Proposal

  23. Cost-Cutting Proposal

  24. Cost-Cutting Proposal

  25. Cost-Cutting Proposal annuity

  26. original machine initial cost $150,000 purchased 4 yrs ago salvage today $50,000 salvage in 6 yrs $10,000 new machine initial cost $200,000 6-year life salvage in 6 yrs $30,000 cost savings $75,000/year net working capital $0 Replacement? CCA rate = 20% required return = 15% marginal tax rate = 44% $150,000 PV PV -PV only question: What will be different if we do project?

  27. Replacement?

  28. Replacement?

  29. Replacement?

  30. required return 20% 5 trucks/year for 4 years truck platforms $10,000 ea facilities lease $24,000/year labor & material $4,000/truck new equipment $60,000 salvage $5,000 NWC $40,000 CCA 20% tax 43.5% Setting a Bid Price

  31. Setting a Bid Price

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