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Chapter10MakingCapitalInvestmentDecisionsMcGraw-Hill/IrwinCopyright©2010byTheMcGraw-HillCompanies,Inc.Allrightsreserved.KeyConceptsandSkills•Understandhowtodeterminetherelevantcashflowsforvarioustypesofproposedinvestments•Understandthevariousmethodsforcomputingoperatingcashflow•Understandhowtosetabidpriceforaproject•Understandhowtoevaluatetheequivalentannualcostofaproject10-2ChapterOutline•ProjectCashFlows:AFirstLook•IncrementalCashFlows•ProFormaFinancialStatementsandProjectCashFlows•MoreaboutProjectCashFlow•AlternativeDefinitionsofOperatingCashFlow•SomeSpecialCasesofDiscountedCashFlowAnalysis10-3RelevantCashFlows•Thecashflowsthatshouldbeincludedinacapitalbudgetinganalysisarethosethatwillonlyoccur(ornotoccur)iftheprojectisaccepted•Thesecashflowsarecalledincrementalcashflows•Thestand-aloneprincipleallowsustoanalyzeeachprojectinisolationfromthefirmsimplybyfocusingonincrementalcashflows10-4AskingtheRightQuestion•Youshouldalwaysaskyourself“WillthiscashflowoccurONLYifweaccepttheproject?”–Iftheansweris“yes,”itshouldbeincludedintheanalysisbecauseitisincremental–Iftheansweris“no,”itshouldnotbeincludedintheanalysisbecauseitwilloccuranyway–Iftheansweris“partofit,”thenweshouldincludethepartthatoccursbecauseoftheproject10-5CommonTypesofCashFlows•Sunkcosts–coststhathaveaccruedinthepast•Opportunitycosts–costsoflostoptions•Sideeffects–Positivesideeffects–benefitstootherprojects–Negativesideeffects–coststootherprojects•Changesinnetworkingcapital•Financingcosts•Taxes10-6ProFormaStatementsandCashFlow•Capitalbudgetingreliesheavilyonproformaaccountingstatements,particularlyincomestatements•Computingcashflows–refresher–OperatingCashFlow(OCF)=EBIT+depreciation–taxes–OCF=Netincome+depreciation(whenthereisnointerestexpense)–CashFlowFromAssets(CFFA)=OCF–netcapitalspending(NCS)–changesinNWC10-7Table10.1ProFormaIncomeStatementSales(50,000unitsat$4.00/unit)$200,000VariableCosts($2.50/unit)125,000Grossprofit$75,000Fixedcosts12,000Depreciation($90,000/3)30,000EBIT$33,000Taxes(34%)11,220NetIncome$21,78010-8Table10.2ProjectedCapitalRequirementsYear0123NWC$20,000$20,000$20,000$20,000NFA90,00060,00030,0000Total$110,000$80,000$50,000$20,00010-9Table10.5ProjectedTotalCashFlowsYear0123OCF$51,780$51,780$51,780ChangeinNWC-$20,00020,000NCS-$90,000CFFA-$110,00$51,780$51,780$71,78010-10MakingTheDecision•Nowthatwehavethecashflows,wecanapplythetechniquesthatwelearnedinChapter9•EnterthecashflowsintothecalculatorandcomputeNPVandIRR–CF0=-110,000;C01=51,780;F01=2;C02=71,780;F02=1–NPV;I=20;CPTNPV=10,648–CPTIRR=25.8%•Shouldweacceptorrejecttheproject?10-11•Danielle'sisafurniturestorethatisconsideringaddingappliancestoitsofferings.Whichofthefollowingshouldbeconsideredincrementalcashflowsofthisproject?I.utilizingthecreditofferedbyasuppliertopurchasetheapplianceinventoryII.benefitingfromincreasedfurnituresalestoappliancecustomersIII.borrowingmoneyfromabanktofundtheapplianceprojectIV.purchasingpartsforinventorytohandleanyappliancerepairsthatmightbenecessaryA.IandIIonlyB.IIIandIVonlyC.I,II,andIVonlyD.II,III,andIVonly复习题•Whichofthefollowingshouldbeincludedintheanalysisofanewproduct?I.moneyalreadyspentforresearchanddevelopmentofthenewproductII.reductioninsalesforacurrentproductoncethenewproductisintroducedIII.increaseinaccountsreceivableneededtofinancesalesofthenewproductIV.marketvalueofamachineownedbythefirmwhichwillbeusedtoproducethenewproductA.IandIIIonlyB.IIandIVonlyC.I,II,andIIIonlyD.II,III,andIVonlyE.I,II,III,andIV复习题•Allofthefollowingarerelatedtoaproposedproject.Whichoftheseshouldbeincludedinthecashflowattimezero?I.purchaseof$1,400ofpartsinventoryneededtosupporttheprojectII.loanof$125,000usedtofinancetheprojectIII.depreciationtaxshieldof$1,100IV.$6,500ofequipmentneededtocommencetheprojectA.IandIIonlyB.IandIVonlyC.IIandIVonlyD.I,II,andIVonlyE.I,II,III,andIV复习题MoreonNWC•WhydowehavetoconsiderchangesinNWCseparately?–GAAPrequiresthatsalesberecordedontheincomestatementwhenmade,notwhencashisreceived–GAAPalsorequiresthatwerecordcostofgoodssoldwhenthecorrespondingsalesaremade,whetherwehaveactuallypaidoursuppliersyet–Finally,wehavetobuyinventorytosupportsales,althoughwehaven’tcollectedcashyet10-15Depreciation•ThedepreciationexpenseusedforcapitalbudgetingshouldbethedepreciationschedulerequiredbytheIRSfortaxpurposes•Depreciationitselfisanon-cashexpense;consequently,itisonlyrelevantbecauseitaffectstaxes•Depreciationtaxshield=DT–D=depreciationexpense–T=marginaltaxrate10-16ComputingDepreciation•Straight-linedepreciation–D=(Initialcost–salvage)/numberofyears–Veryfewassetsaredepreciatedstraight-linefortaxpurposes•MACRS–Needtoknowwhichassetclassisappropriatefortaxpurposes–Multiplypercentagegivenintablebytheinitialcost–Depreciatetozero–Mid-yearconvention10-17After-taxSalvage•Ifthesalvagevalueisdifferentfromthebookvalueoftheasset,thenthereisataxeffect•Bookvalue=initialcost–accumulateddepreciation•After-taxsalvage=salvage–T(salvage–bookvalue)10-18Example:DepreciationandAfter-taxSalvage•Youpurchaseequipmentfor$100,000,anditcosts$10,000tohaveitdeliveredandinstalled.Basedonpastinf