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    FINA 3330 - Notes CH 9

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    fische
    The document discusses Chapter 9 of FINA 3330 which covers making capital investment decisions. It addresses cash flow estimation including pro forma income statements, operating cash flow, change in net working capital, capital spending, and total cash flow. It also discusses net present value (NPV) as a method for evaluating capital projects. An example is provided to illustrate how to estimate cash flows, calculate NPV, and determine if a project should be accepted based on whether NPV is positive or negative.

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    FINA 3330 - Notes CH 9

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    fische
    169 views2 pages
    The document discusses Chapter 9 of FINA 3330 which covers making capital investment decisions. It addresses cash flow estimation including pro forma income statements, operating cash flow, change in net working capital, capital spending, and total cash flow. It also discusses net present value (NPV) as a method for evaluating capital projects. An example is provided to illustrate how to estimate cash flows, calculate NPV, and determine if a project should be accepted based on whether NPV is positive or negative.

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    Chapter nine notes for finance

    Original Title

    FINA 3330 - Notes Ch 9

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    The document discusses Chapter 9 of FINA 3330 which covers making capital investment decisions. It addresses cash flow estimation including pro forma income statements, operating cash flow, change in net working capital, capital spending, and total cash flow. It also discusses net present value (NPV) as a method for evaluating capital projects. An example is provided to illustrate how to estimate cash flows, calculate NPV, and determine if a project should be accepted based on whether NPV is positive or negative.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    169 views2 pages

    FINA 3330 - Notes CH 9

    Uploaded by

    fische
    The document discusses Chapter 9 of FINA 3330 which covers making capital investment decisions. It addresses cash flow estimation including pro forma income statements, operating cash flow, change in net working capital, capital spending, and total cash flow. It also discusses net present value (NPV) as a method for evaluating capital projects. An example is provided to illustrate how to estimate cash flows, calculate NPV, and determine if a project should be accepted based on whether NPV is positive or negative.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
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    FINA 3330 - Chapter 9 (Making Capital Investment Decisions)

    I. Cash Flow Estimation


    A. Pro Forma Income Statements
    B. Operating Cash Flow (OCF)
    C. Change in Net Working Capital (∆NWC)
    D. Capital Spending
    E. Total Cash Flow
    II. NPV

    I. Cash Flow Estimation


    In order to determine the cash flow for a project, the following must be included:
    (1) incremental cash flows (cash flows that would not occur without the project considered).
    (2) opportunity costs (the cash flows lost because of accepting the project)
    (3) side effects (cannibalism)
    (4) change in net working capital (NWC = CA – CL)

    The following will never be included in the cash flow estimation:


    (1) sunk costs (costs already incurred, which are not dependent on accepting the project)
    (2) financing costs (these costs are already considered when calculating the cost of capital)

    Example: Given the following information, prepare a pro-forma cash flow statement: ABC
    Corp. considers buying a new piece of equipment that costs $24,000. This machine is depreciated
    straight line to zero over the 3-year life of the project, and will be sold for $10,000 at the end of
    the project. This company is in the 34 percent tax bracket. As a result of buying the new
    equipment, sales in will grow by 5,000 units in the first year, by 8,000 units in the second year,
    and by 12,000 units in the third year. The company anticipates a selling price per unit of $7. The
    company also has variable costs of $4 per unit, and fixed costs of $5,000, all because of
    acquiring the new machine. In order to start producing, an initial investment $2,000 in net
    working capital is needed, and in the subsequent years for the life of the machine, net working
    capital will be 15 percent of revenue. The company also predicts that, at the end of the project,
    the entire level of inventory will be liquidated.

    Solution:

    A. Pro Forma Income Statement


    Year 1 Year 2 Year 3
    Sales (units) 5,000 8,000 12,000
    Revenue ($7/unit x number of units) 35,000 56,000 84,000
    less: Variable Costs (20,000) (32,000) (48,000)
    less: Fixed Costs (5,000) (5,000) (5,000)
    less: Depreciation (8,000) (8,000) (8,000)
    EBIT 2,000 11,000 23,000
    less: Taxes (34 percent) (680) (3,740) (7,820)
    Net Income 1,320 7,260 15,180
    B. Operating Cash Flow (OCF)
    1. OCF = EBIT + Depreciation – Taxes
    2. OCF = Net Income + Depreciation (bottom-up approach)
    3. OCF = Sales – Costs – Taxes (top-down approach)
    4. OCF = (Sales – Costs) x (1 – Tax Rate) + Depreciation x Tax Rate

    Please note that the formulas above are equivalent. In other words, no matter what formula is
    being used, the resulting OCF will be the same if all calculations are correct.

    For our example, the bottom-up approach will be used:


    Year 1 Year 2 Year 3
    Net Income 1,320 7,260 15,180
    Depreciation 8,000 8,000 8,000
    OCF 9,320 15,260 23,180

    C. Change in Net Working Capital (∆NWC)


    Year 0 Year 1 Year 2 Year 3
    Revenue 0 35,000 56,000 84,000
    Level NWC 2,000 5,250 8,400 12,600
    Liquidation Value in Year 3 (12,600)
    ∆NWC 2,000 3,250 3,150 (8,400)

    D. Capital Spending
    Year 0 Year 1 Year 2 Year 3
    Purchase Price 24,000 0 0 0
    After-tax Proceeds from (6,600)
    Market Sale
    Depreciation Tax Shield 0
    Capital Spending 24,000 (6,600)

    E. Total Cash Flow


    Year 0 Year 1 Year 2 Year 3
    OCF 0 9,320 15,260 23,180
    (∆NWC) (2,000) (3,250) (3,150) 8,400
    (Capital Spending) (24,000) 0 0 6,600
    Total Cash Flow (26,000) 6,070 12,110 38,180

    II. NPV
    Year 0 Year 1 Year 2 Year 3
    Total Cash Flow (26,000) 6,070 12,110 38,180
    Discounted Cash Flows (r = .15) (26,000) 5,278 9,157 25,104
    NPV 13,539

    Because NPV>0, the project should be accepted.

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