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13 Cards in this Set

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MAIN CONCEPT OF CAPITAL BUDGETING
WHICH PROJECT TO INVEST IN
CASH FLOW EFFECTS
* DIRECT EFFECT - RECEIPTS AND PAYMENTS OF CASH WHICH HAS AN IMMEDIATE EFFECT ON THE AMOUNT OF CASH AVAILABLE

INDIRECT EFFECT - EX. TAX EFFECT FROM DEPRECIATION.

NET EFFECT - DIRECT + INDIRECT EFFECT
STAGES OF CASH FLOWS
INCEPTION OF PROJECT
OPERATIONS
DISPOSAL
INCEPTION OF THE PROJECT
Invoice cost + shipping + installation------- xxxxxx
+/- change in WC --- xxxxxx
- Cash proceeds on
sale of old----------- xxxxxx
------
NET CASH OUTFLOW FOR NEW
PPE-------------------XXXXXX
OPERATIONS STAGE
These are Cash Inflows
Cash Flows on a reg,
Basis or ANNUITY
TAX SHIELDS out of
Depreciation
DISPOSAL OF THE PROJECT at the end of the period
Proceeds from Sale
Taxes
If sold at a Loss - Cash
Savings
If sold at a gain - Cash
Out (tax will be paid
for the Gain)
DIRECT AND INDIRECT EFFECTS WHEN ASSETS ARE DISPOSED AT THE END OF THE PROJECT'S LIFE
Indirect effect if there are changes to working capita once the asset is disposed (ex. dismissal of employees)

* If the asset is sold :
direct effect for cash inflow created

* indirect effect for for taxes due ( if it is a gain) or taxes saved ( in case of a loss)

*If the asset is scrapped or donated there "may" be tax savings if the TAX BASIS IS GREATER THAN ZERO (i.e. not fully depreciated asset)
CALCULATE PRE TAX CASH FLOWS
Investment Value is often based on the PRESENT VALUE that investors are expecting to receive in the future
CALCULATE AFTER TAX CASH FLOWS
SHORT CUT

PRE TAX CASH FLOW X (1-TAX RATE)
FACTORS AFFECTING INCOME TAXES, CASH FLOWS AND ASSET DISPOSITION
ABANDONMENT OF ASSETS
SALE OF ASSETS
TRADE IN OF ASSETS
ASSET ABANDONMENT (EFFECT
If asset is abandoned:

Net salvage value is treated as "REDUCTION" of the initial investment in the "NEW" asset

BOOK VALUE OF ABANDONED ASSET- "SUNK" Cost. It is "NOT RELEVANT" when making a decision

REMAINING BOOK VALUE (for tax purposes) is deductible as a "TAX LOSS" w/c reduces TAX Liability in the yr. of abandonment. This tax liability is a REDUCTION of the new asset's initial investment
SALE OF ASSETS (effects)
If new asset acquisition requires the SALE OF OLD ASSETS:

*SUBSEQUENT GAIN OR LOSS has NO EFFECT on the capital expenditure decision. REASON: because the BV of OLD ASSET is a SUNK cost

Cash received from sale of old asset REDUCES the NEW Investment's value

If there is a gain or loss, consider the tax effects:
Gain - the AMOUNT OF INCOME TAX PAID on the gain should be deducted from the SELLING PRICE OF THE OLD ASSET (w/c increases the initial expenditure)

If there is a LOSS, there will be a reduction on tad as a result of the loss. This is treated as a REDUCTION of the NEW investment
ASSET TRADE IN (EFFECTS)
NO GAIN OR LOSS GENERALLY hence, NO TAX EFFECT

The effect is on LATER YEARS

The traded in asset's book value becomes a portion of the depreciable basis of the NEW asset. RESULT: MORE depreciation in later years, MORE REDUCTION IN TAXES PAYABLE IN LATER YEARS.

Therefore, the CASH OUTFLOWS in the later years will DECLINE