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26 Cards in this Set

  • Front
  • Back
The difference between a firm's future cash flows with a project and those without the project is called its ______________________.
incremental cash flows
The assumption that evaluation of a project may be based on the project's incremental cash flows is called the _________________.
stand-alone principle

True OR False:


The incremental cash flows for project evaluation consist of any and all changes in the firm's future cash flows that are a direct consequence of taking the project.

True. Also, as such, any cash flow that exists regardless of whether or not a project is undertaken is not relevant.
A _____________ is a cost that has already been incurred and cannot be recouped; therefore, it should not be considered in an investment decision.
sunk cost
The most valuable alternative that is given up if a particular investment is undertaken is known as a(n) _________________.
opportunity cost
The cash flows of a new project that come at the expense of a firm's existing projects are called _________.
erosion

True OR False:




Erosion is only relevant when sales would not otherwise be lost.

True. In accounting for erosion, it is important to note that any sales lost as a result of our launching a new product might be lost anyway because of future competition.

True OR False:


The firm's investment in net working capital closely resembles a loan.

True. The firm supplies working capital at the beginning and recovers it towards the end.

True OR False:


In analyzing a proposed investment, we will include interest paid and any other financing costs, such as dividends or principal repaid.

False. Our goal in project evaluation is to compare the cash flow from a project to the cost of acquiring that project in order to estimate NPV. We do not include interest paid or any other financing costs because they are something to be analyzed separately.
Financial statements projecting future years' operations are called _____________________ and are an easily understood means of summarizing much of the relevant information for a project.
pro forma financial statements
Whenever we write incremental cash flows, we mean _________ incremental cash flows.
aftertax
What are the three (3) components of cash flow from assets?
  1. operating cash flow
  2. capital spending
  3. additions to net working capital
What is the project cash flow equation?

project cash flow


=


project operating cash flow


-


project change in NWC


-


project capital spending

Given the following income statement data, what is the operating cash flow?




Sales $200,000


Variable Costs $125,000


Fixed Costs $12,000


Depreciation $30,000


EBIT $33,000


Taxes (34%) $11,220


Net Income $21,780

operating cash flow


=


EBIT+depreciation-taxes


=


33,000+30,000-11,220


=


$51,780

True OR False:


Whenever we have an investment in net working capital, that same investment has to be recovered; in other words, the same number needs to appear at some time in the future with the opposite sign.

True.
The tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate.
depreciation tax shield
The tax shield definition of operating cash flow is:

OCF = (sales - costs)*(1-TsubC)+depreciation*TsubC




Where TsubC is the corporate tax rate.

For the year just completed, the Combat Wombat Telestat Co. (CWT) reports sales of $998 and costs of $734. You have collected the following beginning and ending balance sheet information:


Accts. Receivable Beg $100, End $110


Inventory Beg $100, End $80


Accounts Payable Beg $100, End $80


Net Working Capital Beg $100, End $120



Based on these figures, what are cash inflows? Cash outflows? What happened to each account? What is net cash flow?

Sales were $998 but receivables rose by $10. So, cash collections were $10 less than sales, or $988. Costs were $734, but inventories fell by $20. This means that we didn't replace $20 worth of inventory, so costs are actually overstated by this amount.




Also, payables fell by $30. This means that, on a net basis, we actually paid our suppliers $30 more than we received from them, resulting in a $30 understatement of costs. Adjusting for these events, cash costs are $734 - 20 + 30 = $744. Net cash flow is $988 - 744 = $244.




Finally, notice that net working capital increased by $20 overall. We can check our answer by noting that the original accounting sales less costs of $998 - $734 is $264. In addition, CWT spent $20 on net working capital, so the net result is a cash flow of $264 - 20 = $244, as we calculated.

Depreciation method under U.S tax law allowing for the accelerated write-off of property under various classifications.
Accelerated Cost Recovery System (ACRS)
Winnebagel Corp. currently sells 30,000 motor homes per year at $53,000 each, and 12,000 luxury motor coaches per year at $91,000 each. The company wants to introduce a new portable camper to fill out its product line; it hopes to sell 19,000 of these campers per year at $13,000 each. An independent consultant has determined that if Winnebagel introduces the new campers, it should boost the sales of its existing motor homes by 4,500 units per year, and reduce the sales of its motor coaches by 900 units per year. What is the amount to use as an annual sales figure when evaluating this project? Why?

New portable camper: Qty 19,000; Price $; 13,000; Sales $247,000,000


Increase in motor homes: Qty 4500; Price $53,000; Sales $238,500,000


Decrease in motor coaches: Qty (900); Price $91,000; Sales ($81,900,000)




247 + 238.5 -18.9 = 403.6 = $403,600,000

A proposed new investment has projected sales of $839,000. Variable costs are 53 percent of sales, and fixed costs are $187,730; depreciation is $98,000. Assume a tax rate of 40 percent. What is the projected net income?

net income = EBIT - (EBIT*tax rate)


EBIT = sales - variable costs - fixed costs - depreciation


=


839000-(839000*0.53)-187730-98000=108600




108600 - (108600*0.4) = $65,160

Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,520,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,290,000 in annual sales, with costs of $1,280,000. If the tax rate is 40 percent, what is the OCF for this project?

OCF = net income + depreciation


net income = taxable income - (taxable income*tax rate)


taxable income = sales - costs - depreciation


depreciation = (cost-salvage)/life




TI =2290000-1280000-(2520000/3)= 170000


NI = 170000 - (170000*0.4) = 102000


OCF = 102000 + 840000 = $942,000

Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,220,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,190,000 in annual sales, with costs of $1,180,000. The project requires an initial investment in net working capital of $154,000, and the fixed asset will have a market value of $179,000 at the end of the project. Assume that the tax rate is 30 percent and the required return on the project is 13 percent. What are the net cash flows of the project for the following years?

Y0 = -2220000 + -154000 = $2,374,000


Y1 =


Y2 =


Y3 = +179000 +154000




annual dep. = (2220000-179000)/3 = 680333.33

Kolby’s Korndogs is looking at a new sausage system with an installed cost of $801,000. This cost will be depreciated straight-line to zero over the project’s six-year life, at the end of which the sausage system can be scrapped for $112,000. The sausage system will save the firm $200,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $58,000. If the tax rate is 35 percent and the discount rate is 7 percent, what is the NPV of this project?

sausage system = 801000


invest. in NWC =58000


tax rate = 35%, discount rate = 7%


annual costs = (200000)


annual dep. = (801000 - 112000)/6 = 114833.33







We are evaluating a project that costs $1,610,000, has a seven-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 87,500 units per year. Price per unit is $34.50, variable cost per unit is $20.75, and fixed costs are $755,000 per year. The tax rate is 40 percent, and we require a return of 12 percent on this project. Calculate the base-case cash flow and NPV.

base-case NPV = -1610000+360875*4.56375653..=$36,945.55


base-case OCF = 218125+(1610000/7)-(218125*0.4)= $360,875


net income = 218125 - (218125*0.4) = $130875


EBIT = (87500*34.5)-(87500*20.75)-755000-(1610000/7) = $218,125


annuity PVF = [1-(1+0.12)^-7]/0.12 = 4.56375653...



We are evaluating a project that costs $1,610,000, has a seven-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 87,500 units per year. Price per unit is $34.50, variable cost per unit is $20.75, and fixed costs are $755,000 per year. The tax rate is 40 percent, and we require a return of 12 percent on this project. What is the sensitivity of NPV to changes in the sales figure?

base case = unit sales, 87,500; cash flow $360,875; NPV, $36,945.55; IRR,


worst case = unit sales, 87,000; cash flow, $126,750; NPV, -$1,031.543.86


best case =