Finance - Bsns108 - Capital Investment 2

Front 1

Incremental Cash Flows

Back 1

Any changes in the firms future cash flows that are a direct consequence of taking on the project

Front 2

What is the main cash flow we are interested in?

Back 2

Unleveraged Free Cash Flows to Capital (FCF)

Front 3

What does unleveraged mean?

Back 3

No debt

Front 4

What are the four main components of FCF?

Back 4

- Operating Cash Flow (OCF)
- Change in NWC (Net Working Capital)
- CAPEX (Capital Expenditure)
- Tax Effects

Front 5

What is the formula to calculate FCF?

Back 5

OCF - Change in NWC - CAPEX + Tax effects

Front 6

What is the stand alone principle?

Back 6

The assumption that evaluation of a project may be based on the project's incremental cash flows
- Evaluated in isolation from other projects, like a mini-firm

Front 7

Are we interested in before or after tax cash flows?

Back 7

After tax cash flows

Front 8

Sunk Cost

Back 8

A cost that has already been incurred and cannot be gotten back upon accepting or rejecting the project and thus should not be considered in the investment decision

Front 9

Sunk Cost E.g.

Back 9

Consultancy Fee, Market research

Front 10

Opportunity Cost

Back 10

The most valuable alternative that is given up if a particular investment is undertaken

Front 11

Opportunity Cost E.g.

Back 11

Building on a piece of land you own instead of selling it.
Cost is what you could sell it for today, not what you bought it for.

Front 12

Erosion

Back 12

The cash flows of a new project that come at the expense of a firm's existing projects

Front 13

Financing Costs

Back 13

Interest Paid, Dividends Paid, Principal repaid
- These are a component of cash flow to creditors and we only deal with cash flows from assets.
- EXCLUDE

Front 14

A pro forma

Back 14

Projected Financial Statement - a statement projecting future years' operations

Front 15

OCF formula

Back 15

Revenue
- Fixed Costs
- Variable Costs
- Depreciation
----------------------
EBIT
- Taxes
-----------------------
EBIAT
+ Depreciation
------------------------
OCF

Front 16

What can EBIAT also be referred to as?

Back 16

Net Income

Front 17

EBIT

Back 17

Earnings before interest and taxes

Front 18

EBIAT

Back 18

Earnings before interest after taxes

Front 19

What is depreciation?

Back 19

An asset losing value over time

Front 20

What is depreciating 'straight-line to zero'?

Back 20

An equal amount of depreciation occurs each year, until the book value is zero

Front 21

How would we calculate depreciation?

Back 21

Original value of asset/life (number of years) of asset

Front 22

What is Net Working Capital?

Back 22

The money spent at the beginning of the project (capital supplied) to do such things as build up inventory

Front 23

What does NWC do over the life of a project?

Back 23

Negative at start
Constant throughout duration
Recovered at the end

Front 24

Change in NWC equation:

Back 24

Current Assets - Current Liabilities

Front 25

What happens to the NWC if the project is entirely cash?

Back 25

The only change is in the inventory as there are no accounts payable or receivable.

Front 26

What is CAPEX?

Back 26

-Capital Expenditure
- The amount spent on PPE (Property, Plant and Equipment) at the beginning of the project

Front 27

What does CAPEX include other than PPE?

Back 27

Shipping or installation costs

Front 28

What is the CAPEX formula?

Back 28

NET PPE (current)
- NET PPE (prior)
+ Depreciation

Front 29

What is CAPEX often?

Back 29

Just a large outflow of cash at t=0

Front 30

Book value

Back 30

The price calculated

Front 31

Market value

Back 31

The actual price offered when buying or selling (i.e. in the market)

Front 32

Book value equation

Back 32

Initial cost - accumulated depreciation

Front 33

What is the tax effect?

Back 33

The after- tax salvage value

Front 34

What is the salvage value?

Back 34

The price you could sell the asset to someone else for

Front 35

What is the after-tax salvage value equation?

Back 35

After-tax salvage = salvage(selling price) - T x (salvage - book value)

Front 36

What is the T x (Salvage - book value) part of the after-tax salvage value equation?

Back 36

The tax credit

Front 37

What is the alternative way to calculate OCF?

Back 37

The depreciation tax shield

Front 38

Depreciation tax shield equation:

Back 38

OCF = (Sales - costs) x (1-T) + Depreciation x T

Front 39

What is Component 1 of the Depreciation tax shield equation?

Back 39

(Sales - Costs) x (1-T) = project's cash flow if there were no depreciation expense

Front 40

What is Component 2 of the Depreciation tax shield equation?

Back 40

Depreciation x T = Depreciation Tax Shield

Front 41

Forecasting Risk

Back 41

The possibility that errors in projected cash flows will lead to incorrect decisions

Front 42

What are the two main approaches to resolving forecasting risk?

Back 42

- Sources of Value
- Analysis

Front 43

Sources of Value

Back 43

Look at what the main source is that leads to a positive NPV

Front 44

Scenario Analysis

Back 44

Asking what-if questions and looking at the all-round best and worst case scenarios by setting upper and lower limits

Front 45

Sensitivity Analysis

Back 45

Investigation of what happens to NPV when only one variable is changed
- Useful in pinpointing areas where forecasting risk is especially severe

Front 46

What do the two types of analysis' show?

Back 46

Useful in pointing out where forecasting errors will do the most damage but NOT what to about it

Front 47

Interest Payments on Debt

Back 47

ARE tax-deductible

Front 48

What is the benefit of paying tax on debt?

Back 48

It lowers the cost of debt