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Cash Flow Estimation Risk Analysis

All Rights Reserved. Dr. David P. Echevarria. 2. ANALYTICAL METHODOLOGY . A. Tax Considerations When Replacing Old Plant and Equipment.1. Replacement projects are undertaken to reduce costs.2. May involve the disposition of the old asset being replaced.3. Three possible situations when disposing

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Cash Flow Estimation Risk Analysis

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    1. All Rights Reserved Dr. David P. Echevarria 1 Cash Flow Estimation Risk Analysis CHAPTER 9

    2. All Rights Reserved Dr. David P. Echevarria 2 ANALYTICAL METHODOLOGY A. Tax Considerations When Replacing Old Plant and Equipment. 1. Replacement projects are undertaken to reduce costs. 2. May involve the disposition of the old asset being replaced. 3. Three possible situations when disposing (selling) old assets (continued on next slide)

    3. All Rights Reserved Dr. David P. Echevarria 3 ANALYTICAL METHODOLOGY 3. Three possible situations when disposing (selling) old assets If salvage value is less than book = tax credit. The credit is a positive cash flow. If salvage value is equal to book = it's a wash. If salvage value is more than book = tax liability. The liability is a negative cash flow.

    4. All Rights Reserved Dr. David P. Echevarria 4 ANALYTICAL METHODOLOGY Determining Initial Investment (Io) The initial investment (or outlay) is the amount of new cash we must provide to launch the venture. The initial outlay (Io) is assumed to occur on day zero. Io = CFo [-] in the BA II Plus C. Capital Investment Objectives Support additional sales. Lower operating costs. All projects must produce additional ATCF.

    5. All Rights Reserved Dr. David P. Echevarria 5 ANALYTICAL METHODOLOGY D. Learning Strategy 1. I will provide the change in operating income before depreciation and taxes. Depreciation Schedule according to M-ACRS The Net Present Value of a Project (NPV); NPV = S [ATCFn / (1+ka)n] - Io

    6. All Rights Reserved Dr. David P. Echevarria 6 CAPITAL BUDGETING CLASS EXERCISE FIN 335

    7. All Rights Reserved Dr. David P. Echevarria 7 CAPITAL BUDGETING EXERCISE Background Information: New Project Analysis New machine [installed] cost = $ 250,000 Benefit: reduce EBDT by $ 90,000 per year Economic Expected Project Life = 5 years Machine in 3 year ACRS category (ADC % rates = 33, 45, 15, 7 for years 1,2,3,4) Expected Salvage Value at end of 5th year = $ 23,000 Startup Working Capital required = $ 25,000 (to be recouped at end of 5th year) Tax rate = 40%, WACC = 10%

    8. All Rights Reserved Dr. David P. Echevarria 8 Computing Depreciation Schedule

    9. All Rights Reserved Dr. David P. Echevarria 9 Compute After Tax Cash Flows

    10. All Rights Reserved Dr. David P. Echevarria 10 After Tax Cash Flows

    11. All Rights Reserved Dr. David P. Echevarria 11 Compute NPV Using BA II PLUS Press CF key: Use [ENTER] key to save values. Note CFo is a negative value. CFo = -275000 ($250,000 cost of new machine + $25,000 WC needs) ? C01 = 87000 ? F01 = 1 ? C02 = 99000 ? F02 = 1 ? C03 = 69000 ? F03 = 1 ? C04 = 61000 ? F04 = 1 ? C05 = 92800 ? F05 = 1 2ND QUIT Press NPV key I = 10 [?] Press [CPT]: NPV = 37,035.13 Press IRR key Press [CPT] IRR = 15.30 [%]

    12. All Rights Reserved Dr. David P. Echevarria 12 MIRR: Compute FV of ATCF using the WACC (10%) FVIF = (1 + Ka)(5-n) Table 3

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