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    Chapter 6 - Section 2 The Baldwin Company: An Example: Year 1 Year 2 Year 3

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    Meghana Erapaga
    The document discusses capital budgeting for the Baldwin Company project and the effects of inflation. It provides projections for units sold, prices, costs, and other factors for the project over 5 years. It then calculates preliminary values like depreciation, sales revenue, and costs. It shows how to calculate changes in net working capital and the pro forma income statement and cash flows. The key points are: 1) Excel is well-suited for capital budgeting as it involves repetitive cash flows and calculations. 2) Projections are provided for a machine, warehouse, sales, costs, and other factors over 5 years. 3) Preliminary calculations are shown for depreciation, revenue, costs to set

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    Chapter 6 - Section 2 The Baldwin Company: An Example: Year 1 Year 2 Year 3

    Uploaded by

    Meghana Erapaga
    253 views11 pages
    The document discusses capital budgeting for the Baldwin Company project and the effects of inflation. It provides projections for units sold, prices, costs, and other factors for the project over 5 years. It then calculates preliminary values like depreciation, sales revenue, and costs. It shows how to calculate changes in net working capital and the pro forma income statement and cash flows. The key points are: 1) Excel is well-suited for capital budgeting as it involves repetitive cash flows and calculations. 2) Projections are provided for a machine, warehouse, sales, costs, and other factors over 5 years. 3) Preliminary calculations are shown for depreciation, revenue, costs to set

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    Corporate Finance

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    Corporate Finance

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    The document discusses capital budgeting for the Baldwin Company project and the effects of inflation. It provides projections for units sold, prices, costs, and other factors for the project over 5 years. It then calculates preliminary values like depreciation, sales revenue, and costs. It shows how to calculate changes in net working capital and the pro forma income statement and cash flows. The key points are: 1) Excel is well-suited for capital budgeting as it involves repetitive cash flows and calculations. 2) Projections are provided for a machine, warehouse, sales, costs, and other factors over 5 years. 3) Preliminary calculations are shown for depreciation, revenue, costs to set

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
    253 views11 pages

    Chapter 6 - Section 2 The Baldwin Company: An Example: Year 1 Year 2 Year 3

    Uploaded by

    Meghana Erapaga
    The document discusses capital budgeting for the Baldwin Company project and the effects of inflation. It provides projections for units sold, prices, costs, and other factors for the project over 5 years. It then calculates preliminary values like depreciation, sales revenue, and costs. It shows how to calculate changes in net working capital and the pro forma income statement and cash flows. The key points are: 1) Excel is well-suited for capital budgeting as it involves repetitive cash flows and calculations. 2) Projections are provided for a machine, warehouse, sales, costs, and other factors over 5 years. 3) Preliminary calculations are shown for depreciation, revenue, costs to set

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
    of 11
    At a glance
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    The key takeaways are how to calculate cash flows for capital budgeting projects including depreciation, taxes, net working capital, and salvage value. It also discusses the differences between real and nominal cash flows.

    The steps to calculate cash flows for a capital budgeting project are to calculate revenues, operating costs, depreciation, taxes, net working capital changes, and cash flows from operations, investing, and financing for each period of the project.

    Real cash flows are adjusted for inflation while nominal cash flows are not. Real cash flows use the real discount rate while nominal cash flows use the nominal discount rate.

    Chapter 6 - Section 2

    The Baldwin Company: An Example

    Because capital budgeting requires numerous repetitive cash flows, it is an ideal application for Excel. When doing a
    no calculations on your own, but rather let Excel do the calculations for you. We will begin with the Baldwin Compan

    Year 1 Year 2 Year 3


    Units sold per year: 5,000 8,000 12,000
    Price per unit for Year 1: $ 20.00
    Price increase per year: 2%
    Inflation rate: 5%
    Tax rate: 21%
    Unit production cost for Year 1: $ 10.00
    Increase in unit cost per year: 10%
    NWC to start project: $ 10,000
    NWC for subsequent years (as % of sales): 10%
    Depreciation rate: 20.00% 32.00% 19.20%
    Cost of machine $ 100,000
    Cost of warehouse: $ 150,000
    Pretax salvage value: $ 30,000

    We will start off with some preliminary work, including the depreciation each year, sales price, and unit costs:

    Year 1 Year 2 Year 3


    Depreciation
    Accumulated depreciation
    Adjusted basis of machine
    Price per unit
    Sales revenue
    Cost per unit
    Operating costs

    The change in net working capital for each year is the beginning net working capital for each year minus the net wor
    working capital each year is:

    Net working capital


    Beginning NWC
    End of year NWC
    NWC cash flow

    The machine will have a salvage value at the end of the project, but we are concerned with the aftertax salvage valu
    Pretax salvage value
    Taxes on sale
    Aftertax salvage value

    Now we can calculate the pro forma income statement for each year (Table 6.1), which will be:

    Sales revenue
    Operating costs
    Depreciation
    Income before taxes
    Taxes at 21%
    Net income

    With this, the incremental cash flows each year, NPV for different interest rates, and IRR for the project are (Table 6

    Year 0 Year 1 Year 2


    Sales revenue
    Operating costs
    Taxes
    Cash flow from operations
    Bowling ball machine
    Warehouse
    Net working capital
    Total cash flow of project

    NPV
    4%
    10%
    15%

    20%
    or Excel. When doing a capital budgeting problem, as in most Excel uses, you should do few or
    th the Baldwin Company project. We have the following projections for the project:

    Year 4 Year 5
    10,000 6,000

    11.52% 11.52%

    e, and unit costs:

    Year 4 Year 5

    year minus the net working capital investment at the end of the year. So, the change in net

    e aftertax salvage value, which is:


    e:

    he project are (Table 6.4):

    Year 3 Year 4 Year 5


    Initial Cost 80000
    Dep 16000 16000 16000 16000 16000
    Reduction in cost 22000 22000 22000 22000 22000
    tax rate 21%
    pre tax Salvage value 20000
    discount rate 0.1

    Year 0 1 2 3 4 5
    Cash flow from Investing -80000 15800

    Incremental change in EBT 6000 6000 6000 6000 6000


    Incremental change in Tax expense 1260 1260 1260 1260 1260
    add dep 16000 16000 16000 16000 16000
    Cash flow from operation 20740 20740 20740 20740 20740

    Net cash flow -80000 20740 20740 20740 20740 36540

    NPV ₹ 8,431.47
    Price per truck 25709.2418268596 (Assume)
    Number of truck 5
    Cost of platform 10000
    Other cost per truck 4000
    lease cost 24000
    Fixed investment 60,000
    salvage value 5,000
    tax rate 0.21
    discount rate 0.20

    Performa Income statement


    0 1 2 3 4
    Revenue 128546.2 128546.2 128546.2 128546.2
    cost 94000 94000 94000 94000
    Dep 15000 15000 15000 15000
    EBT 19546.21 19546.21 19546.21 19546.21
    Tax 4104.704 4104.704 4104.704 4104.704
    Change in working capital 40000 -40000
    Operating cash flow -40000 30441.51 30441.51 30441.51 70441.51

    Investing cash flow -60,000 3,950

    Total Cash flow -100,000 30,442 30,442 30,442 74,392


    NPV 0.0000000000
    Discount rate 0.06
    Year 0.00 1.00 2.00 3.00
    Machine A -15.00 -5.00 -5.00 -5.00 -28.37
    Machine B -10.00 -6.00 -6.00 -21.00

    Machine A
    Machine B
    Chapter 6 - Section 5
    Inflation and Capital Budgeting

    Inflation should always be considered in any long-term project. As long as inflation is correctly handled, the NPV of t
    projected proposed by Altshuler, Inc.

    Example 6.11: Real and Nominal NPV


    Altshuler, Inc. has generated the following forecast for a capital budgeting project. David Altshuler prefers to work i
    Whose approach is correct?

    Year 0 Year 1 Year 2


    Capital expenditures: $ 1,210
    Revenues (real terms): $ 1,900 $ 2,000
    Cash expenses (real terms): 950 1,000
    Depreciation: 605 605

    Inflation rate: 10.0%


    Nominal rate: 15.5%
    Real rate: 5.0%
    Tax rate: 21.0%

    With these projections, we can generate the following nominal cash flows and NPV:

    Nominal Cash Flows


    Year 0 Year 1 Year 2
    Capital expenditures
    Revenues
    Expenses
    Depreciation
    Taxable income
    Taxes (21%)
    Income after taxes
    Depreciation
    Cash flow

    NPV @ 15.5%

    We can also use real cash flows, which will be:

    Real Cash Flows


    Year 0 Year 1 Year 2
    Capital expenditures
    Revenues
    Expenses
    Depreciation
    Taxable income
    Taxes (21%)
    Income after taxes
    Depreciation
    Cash flow

    NPV @ 5%

    When dealing with any cash flows, it is irrelevant whether you use real cash flows with the real interest rate or nom
    value will always be the same.
    n is correctly handled, the NPV of the project will be the same. For example, consider the

    t. David Altshuler prefers to work in nominal terms, while Stuart Weiss prefers real cash flows.

    PV:
    with the real interest rate or nominal cash flows with the nominal interest rate, the present

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