Capital Budgeting and Estimating Cash Flows

Presentation Transcript

Part 12 Capital Budgeting and Estimating Cash Flows © 2001 Prentice-Hall, Inc. Basics of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI

Capital Budgeting and Estimating Cash Flows The Capital Budgeting Process Generating Investment Project Proposals Estimating Project "After-Tax Incremental Operating Cash Flows"

What is Capital Budgeting? The way toward distinguishing, dissecting, and choosing venture extends whose profits (money streams) are required to reach out past one year.

The Capital Budgeting Process Generate venture proposition steady with the company's key goals. Assess after-duty incremental working money streams for the venture ventures. Assess extend incremental money streams.

The Capital Budgeting Process Select ventures in light of an esteem amplifying acknowledgment foundation. Reexamine actualized speculation extends persistently and perform postaudits for finished activities.

Classification of Investment Project Proposals 1. New items or development of existing items 2. Substitution of existing hardware or structures 3. Innovative work 4. Investigation 5. Other (e.g., wellbeing or contamination related)

Screening Proposals and Decision Making 1. Segment Chiefs 2. Plant Managers 3. VP for Operations 4. Capital Expenditures Committee 5. President 6. Top managerial staff Advancement to the following level relies on upon cost and key significance.

Cash (not bookkeeping pay) streams Operating (not financing) streams After-duty streams Incremental streams Basic qualities of pertinent venture streams Estimating After-Tax Incremental Cash Flows

Ignore sunk costs Include opportunity costs Include extend driven changes in working capital net of unconstrained changes in current liabilities Include impacts of swelling Principles that must be clung to in the estimation Estimating After-Tax Incremental Cash Flows

Tax Considerations and Depreciation speaks to the efficient designation of the cost of a capital resource over a timeframe for money related revealing purposes, assess purposes, or both. For the most part, gainful firms like to utilize a quickened technique for duty announcing purposes (MACRS).

Depreciation and the MACRS Method Everything else level with, the more noteworthy the devaluation charges, the lower the expenses paid by the firm. Devaluation is a noncash cost. Resources are devalued (MACRS) on one of eight diverse property classes. For the most part, the half-year tradition is utilized for MACRS.

MACRS Sample Schedule

Depreciable Basis In assessment bookkeeping, the completely introduced cost of an advantage. This is the sum that, by law, might be composed off after some time for expense purposes. Depreciable Basis = Cost of Asset + Capitalized Expenditures

Capitalized Expenditures Capitalized Expenditures will be uses that may give benefits into the future and in this manner are dealt with as capital costs and not as costs of the period in which they were caused. Cases : Shipping and establishment

Sale or Disposal of a Depreciable Asset Generally, the offer of a "capital resource" (as characterized by the IRS) produces a capital pick up (resource offers for more than book esteem) or capital misfortune (resource offers for not as much as book esteem). Regularly generally, capital increases salary has gotten more good U.S. assess treatment than working salary.

Corporate Capital Gains/Losses Capital misfortunes are deductible just against capital additions . As of now, capital increases are exhausted at customary pay charge rates for organizations, or a most extreme 35%.

Calculating the Incremental Cash Flows Initial money outpouring - the underlying net money venture. Between time incremental net money streams - those net money streams happening after the underlying money venture yet excluding the last time frame's income. Terminal-year incremental net money streams - the last time frame's net income.

Initial Cash Outflow a) Cost of "new" resources b) + Capitalized consumptions c) + (- ) Increased (diminished) NWC d) - Net continues from offer of "old" asset(s) if substitution e) + (- ) Taxes (reserve funds) due to the sale of "old" asset(s) if substitution f) = Initial money surge

Incremental Cash Flows a) Net incr. (decr.) in working income less (in addition to) any net incr. (decr.) in operating costs, barring depr. b) -(+) Net incr. (decr.) in duty deterioration c) = Net change in pay before expenses d) -(+) Net incr. (decr.) in assessments e) = Net change in salary after duties f) + (- ) Net incr. (decr.) in duty depr. charges g) = Incremental net income for period

Terminal-Year Incremental Cash Flows a) Calculate the incremental net money flow for the terminal time frame b) + (- ) Salvage esteem (transfer/recovery costs) of any sold or arranged resources c) -(+) Taxes (impose reserve funds) because of benefit deal or transfer of "new" resources d) + (- ) Decreased (expanded) level of "net" working capital e) = Terminal year incremental net income

Example of an Asset Expansion Project Basket Wonders (BW) is thinking about the buy of another wicker bin weaving machine. The machine will cost $50,000 in addition to $20,000 for transportation and establishment and falls under the 3-year MACRS class. NWC will ascend by $5,000. Lisa Miller figures that incomes will increment by $110,000 for each of the following 4 years and will then be sold (rejected) for $10,000 toward the finish of the fourth year, when the venture closes. Working expenses will ascend by $70,000 for each of the following four years. BW is in the 40% assessment section.

Initial Cash Outflow a) $50,000 b) + 20,000 c) + 5,000 d) - 0 (not a substitution) e) + (- ) 0 (not a substitution) f) = $75,000* * Note that we have figured this incentive as a "positive" since it is a money OUTFLOW (negative).

Incremental Cash Flows Year 1 Year 2 Year 3 Year 4 a) $40,000 $40,000 b) - 23,331 31,115 10,367 5,187 c) = $16,669 $ 8,885 $29,633 $34,813 d) - 6,668 3,554 11,853 13,925 e) = $10,001 $ 5,331 $17,780 $20,888 f) + 23,331 31,115 10,367 5,187 g) = $33,332 $36,446 $28,147 $26,075

Terminal-Year Incremental Cash Flows a) $26,075 The incremental income from the past slide in Year 4. b) + 10,000 Salvage Value. c) - 4,000 .40*($10,000 - 0) Note, the asset is completely devalued at the end of Year 4. d) + 5,000 NWC - Project closes. e) = $37,075 Terminal-year incremental cash stream.

Summary of Project Net Cash Flows Asset Expansion Year 0 Year 1 Year 2 Year 3 Year 4 - $75,000* $33,332 $36,446 $28,147 $37,075 * Notice again that this esteem is a negative income as we figured it as the underlying trade OUT FLOW out slide 12-18.

Example of an Asset Replacement Project Let us accept that past resource development venture is really a benefit substitution extend. The first premise of the machine was $30,000 and deteriorated utilizing straight-line more than five years ($6,000 every year). The machine has two years of devaluation and four years of helpful life remain-ing. BW can offer the present machine for $6,000. The new machine won't build incomes (stay at $110,000) however it diminishes working costs by $10,000 every year (old = $80,000). NWC will ascend to $10,000 from $5,000 (old).

Initial Cash Outflow a) $50,000 b) + 20,000 c) + 5,000 d) - 6,000 (offer of "old" resource) e) - 2,400 <- - f) = $66,600 (charge investment funds from misfortune discounted of "old" resource)

Calculation of the Change in Depreciation Year 1 Year 2 Year 3 Year 4 a) $23,331 $31,115 $10,367 $ 5,187 b) - 6,000 0 c) = $17,331 $25,115 $10,367 $ 5,187 a) Represent the deterioration on the "new" project. b) Represent the rest of the devaluation on the "old" extend. c) Net change in duty deterioration charges.

Incremental Cash Flows Year 1 Year 2 Year 3 Year 4 a) $10,000 $10,000 b) - 17,331 25,115 10,367 5,187 c) = $ - 7,331 - $15,115 $ - 367 $ 4,813 d) - - 2,932 - 6,046 - 147 1,925 e) = $ - 4,399 $ - 9,069 $ - 220 $ 2,888 f) + 17,331 25,115 10,367 5,187 g) = $12,932 $16,046 $10,147 $ 8,075

Terminal-Year Incremental Cash Flows a) $ 8,075 The incremental income from the past slide in Year 4. b) + 10,000 Salvage Value. c) - 4,000 (.40)*($10,000 - 0). Take note of, the asset is completely deteriorated at the end of Year 4. d) + 5,000 Return of "included" NWC. e) = $19,075 Terminal-year incremental cash stream.

Summary of Project Net Cash Flows Asset Expansion Year 0 Year 1 Year 2 Year 3 Year 4 - $75,000 $33,332 $36,446 $28,147 $37,075 Asset Replacement Year 0 Year 1 Year 2 Year 3 Year 4 - $66,600 $12,933 $16,046 $10,147 $19,075