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19 Cards in this Set
- Front
- Back
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Why do only the changes in cash flows and not the totals matter in capital budgeting decisions?
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The decision to take or not take the project can "make a difference" (either good or bad to the firm. The key is to analyze the situation with and without the new investment and where all relevant costs and benefits are brought into play.
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Why should we consider the incremental operating cash flows on an after-tax basis?
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Because the initial investment outflow, as well as the appropriate discount rate will be expressed in after tax terms.
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When a capital investment contains a current asset component, how should it be treated in capital budgeting decisions?
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These should be treated as part of the capital investment and not as a separate working capital decision. This investment in corking capital should be treated as a cash outflow at the time it occurs.
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Now do you determine changes in net working capital?
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Changes in current assets caused by the project; less the change in current liabilities caused by the project.
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Why ignore sunk costs in capital budgeting decisions?
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Unrecoverable past cash outlays that, since they cannot be recovered, shoudl not affect present actions or future decisions. Sunk costs affect past, not future, cash flows.
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Should opportunity costs be taken into consideration for capital budgeting decisions?
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If a resource has multiple uses, when a firm uses it for the project, it loses the opportunity for other usage purposes, which can also be beneficial to the firm.
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What is cannibalization?
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A situation when a new project reduces cash flows that the firm would otherwise have had without the project.
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What's unique to an expansion project in extimating inintial cash flows?
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There is no old asset, and therefore you don't need to worry about CF for sale of equipment or tax adjustments from that sale for the initial cash flow
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What's unique to a replacment project in estimating initial cash flows?
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You have old assets to sell, and this sale generates cash inflow/outflow.
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ABC Co. is planning to buy a new machine for $200,000. This new machine is expected to have a useful life of six years (MARCS 5 yr). It will cost $4,000 for delivery and $9,000 for instalation. New machine will replace an old machine that was purchased three years ago for $100,000 (replacment proj). This old machine also has a useful life of six years (5 yr Marcs). Marginal tax is 34%. If the company will sell old machine for $50,000. Calculate the initial cash outlay for the new machine.
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Step 1 - Book value 29,000 (from marcs) - selling price 50,000 = -21,000 gain taxed at 34% = -7,140 cash outflow for tax. Step 2 New asset cost -200,000, capital exp (-9000 -4000) -13,000 -NWC 0, CF related to the sale of the old asset +50,000. tax payment -7,140 = -170,140
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When estimating cash inflows, what two steps should you follow?
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Step 1 - calculate net tax effect on the replacment machine (skip if expansion). Step 2 - Plug #'s into formula.
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ABC Co. is planning to buy a new machine for $200,000. This new machine is expected to have a useful life of six years (MARCS 5 yr). It will cost $4,000 for delivery and $9,000 for instalation. New machine will replace an old machine that was purchased three years ago for $100,000 (replacment proj). This old machine also has a useful life of six years (5 yr Marcs). Marginal tax is 34%. If the company will sell old machine for $20,000. Calculate the initial cash outlay for the new machine.
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Step 1 - Book value 29,000 (from marcs) - selling price 20,000 = 9,000 loss taxed at 34% = +3,060 cash inflow for tax. Step 2 New asset cost -200,000, capital exp (-9000 -4000) -13,000. NWC 0, CF related to the sale of the old asset +20,000. tax saving + 3,060 = -189,940
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(Expansion project) - New machine should cost 9,000. Machine has life of 4 yrs (3 yr marcs). Installation costs 400 and has salvage value of 2,000. The machine is expected to generate reve before depreciation and tases of 1 = 3,553; 2 = 3,760 3 = 5,152, 4 = 3,115. Marginal tax rate = 34%. Determine initial Cash flows
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Cost of new asset - 9,000. Capital expenditures -400 = -9,400
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What are the four steps in cash flow analysis?
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Step 1 - Determine Initial Cash Flow. Step 2 - Determine interim incremental operating cash flows. Step 3 - Determine the terminal incremental net cash flow. Step 4 - Write down all the incremental cash flow due to the new project.
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(Expansion project) - New machine should cost 9,000. Machine has life of 4 yrs (3 yr marcs). Installation costs 400 and has salvage value of 2,000. The machine is expected to generate reve before depreciation and tases of 1 = 3,553; 2 = 3,760 3 = 5,152, 4 = 3,115. Marginal tax rate = 34%. Determine interim cash flows.
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Year 1 - 3,400; Year 2 - 3,920; Year 3 - 3,880; Year 4 - 2,280.
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(Expansion project) - New machine should cost 9,000. Machine has life of 4 yrs (3 yr marcs). Installation costs 400 and has salvage value of 2,000. The machine is expected to generate reve before depreciation and tases of 1 = 3,553; 2 = 3,760 3 = 5,152, 4 = 3,115. Marginal tax rate = 34%. Determine Terminal cash flows.
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Net Operating cash flow for terminal year 2,280. Final salvage value 2,200 Taxes paid for sale of new asset - 680 = Terminal cash inflow of 3,600.
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(Replacment example) A co looking to purchase machine to replace new one. Tax rate 40%. Price 18,500, Instalation 1,500. Will cut labor and maint by 7,100 before taxes yearly. No Salvage value on new machine. New machine 3 yr macrs. Old eq has useful life of 4 yrs and book value of 2,000. Old machine has no salvage value. Old machine original depreciable basis was 9.000. Fell into 3 yr property class MACRS. Remaining depreciable life is 2 years. Determine Initial cash flow
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Step 1 - Machine is sold for book value. No tax expense or savings
Step 2 - Cost of asset -18,500. Capitalized exp -1,500. Sale of old asset +2,000 = -18,000 |
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(Replacment example) A co looking to purchase machine to replace new one. Tax rate 40%. Price 18,500, Instalation 1,500. Will cut labor and maint by 7,100 before taxes yearly. No Salvage value on new machine. New machine 3 yr macrs. Old eq has useful life of 4 yrs and book value of 2,000. Old machine has no salvage value. Old machine original depreciable basis was 9.000. Fell into 3 yr property class MACRS. Remaining depreciable life is 2 years. Determine determine interim incremental cash flow.
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Take depreciation rates of new machine and subtact depreciation of old machine for changes in depreciation charges. Yr 1 6,393, Yr 2 7,549, Yr 3 5,445, Yr 4 4,853
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(Replacment example) A co looking to purchase machine to replace new one. Tax rate 40%. Price 18,500, Instalation 1,500. Will cut labor and maint by 7,100 before taxes yearly. No Salvage value on new machine. New machine 3 yr macrs. Old eq has useful life of 4 yrs and book value of 2,000. Old machine has no salvage value. Old machine original depreciable basis was 9.000. Fell into 3 yr property class MACRS. Remaining depreciable life is 2 years. Determine terminal cash flow
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Operating cash flow at last year 4,853. Salvage value of new asset = 0. Taxes do to sale = 0. Total = 4,853
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