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8/9/2019 FM10e_ch10_1 - trim Cash Flows and Other Topics in Capital Budgeting.ppt
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Capital Budgeting tepsCapital Budgeting teps
1313 4'aluate Cash Flows4'aluate Cash Flows5oo+ at all incremental cash flows5oo+ at all incremental cash flowsoccurring as a result of the pro(ect.occurring as a result of the pro(ect.
)nitial outla,)niti
al outla,
6ifferential Cash Flows6ifferential Cash Flows o'er the lifeo'er the life
of the pro(ect 7also referred to asof the pro(ect 7also referred to asannual cash flows3.annual cash flows3.
Terminal Cash FlowsTerminal Cash Flows
8/9/2019 FM10e_ch10_1 - trim Cash Flows and Other Topics in Capital Budgeting.ppt
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Capital Budgeting tepsCapital Budgeting teps
1313 4'aluate Cash Flows4'aluate Cash Flows
" 1 2 / * n8 . . .
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Capital Budgeting tepsCapital Budgeting teps
1313 4'aluate Cash Flows4'aluate Cash Flows
" 1 2 / * n8 . . .
)nitialoutla,
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Capital Budgeting tepsCapital Budgeting teps
1313 4'aluate Cash Flows4'aluate Cash Flows
" 1 2 / * n8 . . .
9nnual Cash Flows
)nitialoutla,
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Capital Budgeting tepsCapital Budgeting teps
1313 4'aluate Cash Flows4'aluate Cash Flows
" 1 2 / * n8 . . .
TerminalCash flow
9nnual Cash Flows
)nitialoutla,
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2323 4'aluate the is+ of the ;ro(ect4'aluate the is+ of the ;ro (ect%e
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/3/3 9ccept or e(ect the ;ro(ect9cc ept or e(ect the ;ro(ect
Capital Budgeting Steps
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
a3a3 )nitial Outla,)nitial Ou tla, :: %hat is the cash flow at%hat is the cash flow at=time " >=time " >
7;urchase price of the asset37;urchase price of the asset3? 7? 7 shipping and installation costs3shi pping and installation costs3
76eprecia&le asset376eprecia&le asset3
? 7)n'estment in wor+ing capital3? 7)n'estment in wor+ing capital3 ?? 9fter-tax proceeds from sale of old asset9fter-tax proceeds from sale of old asset
@et )nitial Outla,@et )nitial Outla,
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
a3a3 )nitial Outla,)nitial Ou tla, :: %hat is the cash flow at%hat is the cash flow at=time " >=time " >
712 !"""3712 !"""3? 7? 7 2"!"""2"!""" 33
76eprecia&le asset376eprecia&le asset3
? 7)n'estment in wor+ing capital3? 7)n'estment in wor+ing capital3 ?? 9fter-tax proceeds from sale of old asset9fter-tax proceeds from sale of old asset
@et )nitial Outla,@et )nitial Outla,
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
a3a3 )nitial Outla,)nitial Ou tla, :: %hat is the cash flow at%hat is the cash flow at=time " >=time " >
712 !"""3712 !"""3? 7? 7 2"!"""2"!""" 33
71* !"""371* !"""3
? 7)n'estment in wor+ing capital3? 7)n'estment in wor+ing capital3 ?? 9fter-tax proceeds from sale of old asset9fter-tax proceeds from sale of old asset
@et )nitial Outla,@et )nitial Outla,
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
a3a3 )nitial Outla,)nitial Ou tla, :: %hat is the cash flow at%hat is the cash flow at=time " >=time " >
712 !"""3712 !"""3? 7? 7 2"!"""2" !""" 33
71* !"""371* !"""3
? 7*!"""3? 7*!"""3 ?? 9fter-tax proceeds from sale of old asset9fter-tax proceeds from sale of old asset
@et )nitial Outla,@et )nitial Outla,
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
a3a3 )nitial Outla,)nitial Outla , :: %hat is the cash flow at%hat is the cash flow at=time " >=time " >
712 !"""3712 !"""3? 7? 7 2"!"""2" !""" 33
71* !"""371* !"""3
? 7*!"""3? 7*!"""3 ?? " "
@et )nitial Outla,@et )nitial Outla,
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
a3a3 )nitial Outla,)nitial Ou tla, :: %hat is the cash flow at%hat is the cash flow at=time " >=time " >
712 !"""3712 !"""3 ;urchase price of asset ;urchase price of asset? 7? 7 2"!"""2" !""" 33 hipping and installation hipping and installation
71* !"""371* !"""3 6eprecia&le asset 6eprecia&le asset
? 7*!"""3? 7*!"""3 @et wor+ing capital @et wor+ing capital?? " " ;roceeds from sale of old asset ;roceeds from sale of old asset
7$1 1!"""3 @et initial outla,7$1 1!"""3 @et initial outla,
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
a3a3 )nitial Outla,)nitial Ou tla, :: %hat is the cash flow at%hat is the cash flow at=time " >=time " >
712 !"""3 ;urchase price of asset712 !"""3 ;urchase price of asset? 7? 7 2"!"""2" !""" 3 hipping and installation3 hipping and installation
71* !"""3 6eprecia&le asset71* !"""3 6eprecia&le asset
? 7*!"""3 @et wor+ing capital? 7*!"""3 @et wor+ing capital?? " " ;roceeds from sale of old asset ;roceeds from sale of old asset
7$1 1!"""3 @et initial outla,7$1 1!"""3 @et initial outla,
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
&3&3 9nnual Cash Flows9nnual Cash Flows :: %hat%hatincremental cash flows occur o'er theincremental cash flows occur o'er thelife of the pro(ectlife of the pro(ect
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)ncremental re'enue)ncremental re'enue
- )ncremental costs- )ncremental costs
-- 6epreciation on pro(ect6epreciation on pro(ect
)ncremental earnings &efore taxes)ncremental earnings &efore taxes-- Tax on incremental 4BTTax on incremental 4BT
)ncremental earnings after taxes)ncremental earnings after taxes?? 6epreciation re'ersal6epreciation re'ersal
9nnual Cash Flow9nnual Cash Flow
For 4ach Aear! Calculate:For 4ach Aear! Calculate:
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)ncremental re'enue)ncremental re'enue
- )ncremental costs- )ncremental costs
-- 6epreciation on pro(ect6e preciation on pro(ect
)ncremental earnings &efore taxes)ncremental earnings &efore taxes-- Tax on incremental 4BTTax on incremental 4BT
)ncremental earnings after taxes)ncremental earnings after taxes?? 6epreciation re'ersal6e preciation re'ersal
9nnual Cash Flow9nnual Cash Flow
For Aears 1 - :For Aears 1 - :
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!"""!"""
72 ! "372 ! "3
-- 6epreciation on pro(ect6epreciation on pro(ect
)ncremental earnings &efore taxes)ncremental earnings &efore taxes-- Tax on incremental 4BTTax on incremental 4BT
)ncremental earnings after taxes)ncremental earnings after taxes?? 6epreciation re'ersal6epreciation re'ersal
9nnual Cash Flow9nnual Cash Flow
For Aears 1 - :For Aears 1 - :
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!"""!"""
72 ! "372 ! "3
72 !*""372 !*""3
)ncremental earnings &efore taxes)ncremental earnings &efore taxes-- Tax on incremental 4BTTax on incremental 4BT
)ncremental earnings after taxes)ncremental earnings after taxes?? 6epreciation re'ersal6epreciation re'ersal
9nnual Cash Flow9nnual Cash Flow
For Aears 1 - :For Aears 1 - :
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!"""!"""
72 ! "372 ! "3
72 !*""372 !*""3
2 ! "2 ! " 7 ! 37 ! 3
)ncremental earnings after taxes)ncremental earnings after taxes?? 6epreciation re'ersal6epreciation re'ersal
9nnual Cash Flow9nnual Cash Flow
For Aears 1 - :For Aears 1 - :
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!"""!"""
72 ! "372 ! "3
72 !*""372 !*""3
2 ! "2 ! " 7 ! 37 ! 3
1 !"811 !"81?? 6epreciation re'ersal6e preciation re'ersal
9nnual Cash Flow9nnual Cash Flow
For Aears 1 - :For Aears 1 - :
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!"""!""" e'enuee'enue
72 ! "372 ! "3 CostsCosts
772 !*""2 !*"" 33 6epreciation6epreciation
2 ! "2 ! " 4BT4BT 77 !! 33 Taxes Taxes
1 !"811 !"81
49T49T
2 !*""2 !*"" 6epreciation re'ersal6epreciation re'ersal
*8!*81*8!*81 9nnual Cash Flow9nnual Cash Flow
For Aears 1 - :For Aears 1 - :
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
c3c3 Terminal Cash FlowTerminal Cash Flow :: %hat is the cash%hat is the cashflow at the end of the pro(ect
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
c3c3 Terminal Cash FlowTerminal Cash Flow :: %hat is the cash%hat is the cashflow at the end of the pro(ect
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Tax 4ffects of ale of 9sset:Tax 4ffects of ale of 9sset:
al'age 'alue al'age 'alue $ "!""".$ "!""".Boo+ 'alue deprecia&le asset - totalBoo+ 'alue deprecia&le asset - totalamount depreciated.amount depreciated.
Boo+ 'alue $1* !""" - $1* !"""Boo+ 'alue $1* !""" - $1* !""" $". $".
Capital gain E - BECapital gain E - BE
"!""" - " $ "!""". "!""" - " $ "!""".
Tax pa,ment "!""" x ./* Tax pa,ment "!""" x ./* 7$1 !"""3.7$1 !"""3.
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tep 1: 4'aluate Cash Flowstep 1: 4'aluate Cash Flows
c3c3 Terminal Cash FlowTerminal Cash Flow :: %hat is the cash%hat is the cashflow at the end of the pro(ect
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;ro(ect @;E:;ro(ect @;E:
CF7"3 CF7"3 -1 1!""".-1 1!""".
CF71 - *3 CF71 - *3 *8!*81.*8!*81.
CF7 3 *8!*81 ? / !""" CF7 3 *8!*81 ? / !""" /!*81./!*81.
6iscount rate 6iscount rate 1*0.1*0.
@;E @;E $2 ! 21.$2 ! 21.%e would%e would acceptaccept the pro(ect.the pro(ect.
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Capital ationingCapital ationing
uppose that ,ou ha'e e'aluateduppose that ,ou ha'e e'aluatedfi'e capital in'estment pro(ectsfi'e capital in'estment pro(ects for ,our compan,.for ,our compan,.
uppose that the E; of Financeuppose that the E; of Financehas gi'en ,ou ahas gi'en ,ou a limited capitallimited capital
&udget&udget ..#ow do ,ou decide which#ow do ,ou decide whichpro(ects to selectpro(ects to select
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Capital ationingCapital ationing
Aou could ran+ the pro(ects &, ) :Aou could ran+ the pro(ects &, ) :
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Capital ationingCapital ationing
)
01"0
1 0
2"0
2 0
$
11
Aou could ran+ the pro(ects &, ) :Aou could ran+ the pro(ects &, ) :
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Capital ationingCapital ationing
Aou could ran+ the pro(ects &, ) :Aou could ran+ the pro(ects &, ) :)
01"0
1 0
2"0
2 0
$
11 22
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Capital ationingCapital ationing
Aou could ran+ the pro(ects &, ) :Aou could ran+ the pro(ects &, ) :)
01"0
1 0
2"0
2 0
$
11 22 //
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Capital ationingCapital ationing
Aou could ran+ the pro(ects &, ) :Aou could ran+ the pro(ects &, ) :)
01"0
1 0
2"0
2 0
$
11 22 // **
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Capital ationingCapital ationing
Aou could ran+ the pro(ects &, ) :Aou could ran+ the pro(ects &, ) :)
01"0
1 0
2"0
2 0
$
11 22 // **
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Capital ationingCapital ationing
Aou could ran+ the pro(ects &, ) :Aou could ran+ the pro(ects &, ) :)
01"0
1 0
2"0
2 0
$
11 22 // **
$
Our &udget is limited
so we accept onl,pro(ects 1! 2! and /.
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Capital ationingCapital ationing
Aou could ran+ the pro(ects &, ) :Aou could ran+ the pro(ects &, ) :)
01"0
1 0
2"0
2 0
$
11 22 //
$
Our &udget is limited
so we accept onl,pro(ects 1! 2! and /.
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;ro&lems with ;ro(ect an+ing;ro&lems with ;ro(ect an+ing
13 Gutuall, exclusi'e pro(ects of13 Gutuall, exclusi'e pro(ects of uneHualune HualsiIesiIe 7the7the siIe disparit,siIe dis parit, pro&lem3pro&lem3
The @;E decision ma, not agree withThe @;E decision ma, not agree with) or ;).) or ;).
olution:olution: select the pro(ect with theselect the pro(ect with thelargestlargest @;E@;E ..
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iIe 6isparit, 4xampleiIe 6isparit, 4xample
;ro(ect B;ro(ect B
,ear,ear cash flowcash flow
"" 7/"!"""37/"!"""3
11 1 !""" 1 !"""
22 1 !""" 1 !"""
// 1 !""" 1 !"""reHuired return 120reHuired return 120
) ) 2/./ 02/./ 0
@;E $8!"2@;E $8!"2
;) 1.2";) 1.2"
;ro(ect 9;ro(ect 9
,ear,ear cash flowcash flow
"" 71/ !"""371/ !"""3
11 8"!""" 8"!"""
22 8"!""" 8"!"""
// 8"!""" 8"!"""reHuired return 120reHuired return 120
) 1 .) 1 . 00
@;E $ !11"@;E $ !11"
;) 1.";) 1."
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iIe 6isparit, 4xampleiIe 6isparit, 4xample
;ro(ect B;ro(ect B
,ear,ear cash flowcash flow
"" 7/"!"""37/"!"""3
11 1 !""" 1 !"""
22 1 !""" 1 !"""
// 1 !""" 1 !"""reHuired return 120reHuired return 120
) 2/./ 0) 2/./ 0
@;E $8!"2@;E $8!"2
;) 1.2";) 1.2"
;ro(ect 9;ro(ect 9
,ear,ear cash flowcash flow
"" 71/ !"""371/ !"""3
11 8"!""" 8"!"""
22 8"!""" 8"!"""
// 8"!""" 8"!"""reHuired return 120reHuired return 120
) 1 .) 1 . 00
@;E $ !11"@;E $ !11"
;) 1.";) 1."
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;ro&lems with ;ro(ect an+ing;ro&lems with ;ro(ect an+ing23 The23 The time disparit,time dis parit, pro&lem with mutuall,pro&lem with mutuall,
exclusi'e pro(ects.exclusi'e pro(ects.
@;E and ;) assume cash flows are@;E and ;) assume cash flows arerein'ested at the reHuired rate of returnrein'ested at the reHuired rate of return forforthe pro(ect.the pro(ect.
) assumes cash flows are) assumes cash flows are rein'ested atrein'ested atthe ) .the ) .
The @;E or ;) decision ma, not agree withThe @;E or ;) decision ma, not agree withthe ) .the ) .
olution:olution: select the largestselect the largest @;E@;E ..
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Time 6isparit, 4xampleTime 6isparit, 4xample
;ro(ect 9;ro(ect 9
,ear,ear cash flowcash flow "" 7* !"""3 7* !"""3
11 1!2"" 1!2""
22 2!*"" 2!*""
// / !""" / !"""
** *2!""" *2!"""
reHuired return 120reHuired return 120
) 1 .1"0) 1 .1"0
@;E @;E $ !*/8$ !*/8
;) 1.2";) 1.2"
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Time 6isparit, 4xampleTime 6isparit, 4xample
;ro(ect B;ro(ect B
,ear,ear cash flowcash flow "" 7*8! ""37*8! ""3
11 /8! "" /8! ""
22 2*!""" 2*!"""
// 2!*"" 2!*""
** 2!*"" 2!*""
reHuired return 120reHuired return 120
) ) 2 . 102 . 10
@;E $ !*@;E $ !*
;) 1.1;) 1.1
;ro(ect 9;ro(ect 9
,ear,ear cash flowcash flow "" 7* !"""3 7* !"""3
11 1!2"" 1!2""
22 2!*"" 2!*""
// / !""" / !"""
** *2!""" *2!"""
reHuired return 120reHuired return 120
) 1 .1") 1 .1" 00
@;E $ !*/8@;E $ !*/8
;) 1.2";) 1.2"
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Gutuall, 4xclusi'e )n'estmentsGutuall, 4xclusi'e )n'estmentswithwith JneHual 5i'esJneHual 5i'es
uppose our firm is planning to expanduppose our firm is planning to expandand we ha'e to select one of two machines.and we ha'e to select one of two machines.
The, differ in terms ofThe, differ in terms of economic lifeeconomic life andandcapacit,ca pacit, ..
#ow do we decide which machine to select#ow do we decide which machine to select
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The after-tax cash flows are:The after-tax cash flows are:
AearAear Gachine 1Gachine 1 Gachine 2Gachine 2
" 7* !"""3 7* !"""3" 7* !"""3 7* !"""3
1 2"!""" 12!"""1 2"!""" 12!"""
2 2"!""" 12!"""2 2"!""" 12!""" / 2"!""" 12!"""/ 2"!""" 12!"""
* 12!"""* 12!"""
12!""" 12!"""
8 12!"""8 12!"""
9ssume a reHuired return of 1*0.9ssume a reHuired return of 1*0.
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tep 1: Calculate @;Etep 1: Calculate @;E
@;E@;E 11 $1!*//$1!*//@;E@;E 22 $1!88*$1!88*
o! does this mean K2 is &ettero! does this mean K2 is &etter
@oL The two @;Es can
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tep 2: 4Hui'alent 9nnualtep 2: 4Hui'alent 9nnual9nnuit, 74993 method9nnuit, 74993 method
)f we assume that each pro(ect will &e)f we assume that each pro(ect will &ereplaced an infinite num&er of timesreplaced an infinite num&er of times in thein the
future! we can con'ert each @;E to anfuture! we can con'ert each @;E to anannuit,annui t, ..
The pro(ects< 499sThe pro(ects< 499s cancan &e compared to&e compared to
determine which is the &est pro(ectLdetermine which is the &est pro(ectL
499:499: impl, annuitiIe the @;E o'er theimpl, annuitiIe the @;E o'er thepro(ect
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499 with ,our calculator:499 with ,our calculator:
impl, =spread the @;E o'er the lifeimpl, =spread the @;E o'er the lifeof the pro(ect>of the pro(ect>
Machine 1 Machine 1 :: ;E 1*//! @ /! ) 1*!;E 1*//! @ /! ) 1*! sol'e:sol'e: ;GT -81 .2*;GT -81 .2* ..
Machine 2 Machine 2 :: ;E 188*! @ 8! ) 1*!;E 188*! @ 8! ) 1*!
sol'e:sol'e: ;GT -*2 . 1;GT -*2 . 1 ..
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499499 11 $81 $81
499499 22 $*2 $*2
This tells us that:This tells us that:
@;E@;E 11 annuit, of annuit, of $81$81 per ,ear.per ,ear.
@;E@;E 22 annuit, of annuit, of $*2$*2 per ,ear.per ,ear.o! we
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t / C ' t & + t @ Etep /: Con'ert &ac+ to @;E
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tep /: Con'ert &ac+ to @;Etep /: Con'ert &ac+ to @;E
9ssuming infinite replacement! the9ssuming infinite replacement! the499s are actuall, perpetuities. Met the499s are actuall, perpetuities. Met the;E &, di'iding the 499 &, the reHuired;E &, di'iding the 499 &, the reHuired
rate of return.rate of return.
tep / Con'ert & c+ to @ Etep /: Con'ert &ac+ to @;E
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tep /: Con'ert &ac+ to @;Etep /: Con'ert &ac+ to @;E
9ssuming infinite replacement! the9ssuming infinite replacement! the499s are actuall, perpetuities. Met the499s are actuall, perpetuities. Met the;E &, di'iding the 499 &, the reHuired;E &, di'iding the 499 &, the reHuired
rate of return.rate of return.
@;E@;E 11 81 D.1* $*!*" 81 D.1* $*!*"
tep /: Con'ert &ac+ to @;Etep /: Con'ert &ac+ to @;E
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tep /: Con'ert &ac+ to @;Etep /: Con ert &ac+ to @;E
9ssuming infinite replacement! the9ssuming infinite replacement! the499s are actuall, perpetuities. Met the499s are actuall, perpetuities. Met the;E &, di'iding the 499 &, the reHuired;E &, di'iding the 499 &, the reHuired
rate of return.rate of return.
@;E@;E 11 81 D.1* $*!*" 81 D.1* $*!*"
@;E@;E 22
*2 D.1* $/!" *2 D.1* $/!"
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i &l
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;ractice ;ro&lems:;ractice ;ro&lems:Cash Flows N Other TopicsCash Flows N Other Topics
in Capital Budgetingin Capital Budgeting
Project Information
Project Information :: ;ro&lem 1a;ro&lem 1a
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jjCost of eHuipment Cost of eHuipment $*""!"""$*""!""" ..
hipping N installation will &ehipping N installation will &e $2"!"""$2"!""" ..$2 !"""$2 !""" in net wor+ing capital reHuired at setup.in net wor+ing capital reHuired at setup./-,ear pro(ect life! -,ear class life./-,ear pro(ect life! -,ear class life.
implified straight line depreciation.implified straight line depreciation.e'enues will increase &,e'enues will increase &, $22"!"""$22"!""" per ,ear.per ,ear.
6efects costs will fall &,6efects costs will fall &, $1"!"""$1"!""" per ,ear.per ,ear.
Operating costs will rise &,Operating costs will rise &, $/"!"""$/"!""" per ,ear.per ,ear.al'age 'alue after ,ear / isal'age 'alue after ,ear / is $2""!"""$2""!""" ..
Cost of capital Cost of capital 120!120! marginal tax rate marginal tax rate /*0/*0 ..
;ro&lem 1a;ro&lem 1a
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;ro&lem 1a;ro&lem 1a Initial Outlay Initial Out lay ::
7*""!"""37*""!"""3 Cost of assetCost of asset
? 7? 7 2"!""" 2"!""" 33 hipping N installationhipping N installation 7*2"!"""37*2"!"""3 6eprecia&le asset6eprecia&le asset
? 7? 7 2 !""" 2 !""" 33 )n'estment in @%C)n'estment in @%C 7$** !"""37$** !"""3 @et )nitial Outla,@et )nitial Outla,
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;ro&lem 1a;ro&lem 1a
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Terminal Cash lo!Terminal Cash lo! ::
al'age 'alueal'age 'alue
?D- Tax effects of capital gainDloss?D- Tax effects of capital gainDloss?? ecapture of net wor+ing capitale capture of net wor+ing capital
Terminal Cash FlowTerminal Cash Flow
;ro&lem 1a;ro&lem 1a
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;ro&lem 1a;ro&lem 1a
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Terminal Cash lo!Terminal Cash lo!
::
2""!""" al'age 'alue2""!""" al'age 'alue
71"! "3 Tax on capital gain71"! "3 Tax on capital gain 2 !"""2 !""" ecapture of @%C ecapture of @%C
21*!12" Terminal Cash Flow21*!12" Terminal Cash Flow
;ro&lem 1a;ro&lem 1a
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;ro&lem 1&;ro&lem 1&
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Project Information Project Information ::
For the same pro(ect! suppose weFor the same pro(ect! suppose wecan onl, get $1""!""" for the oldcan onl, get $1""!""" for the oldeHuipment after ,ear /! due toeHuipment after ,ear /! due torapidl, changing technolog,.rapidl, changing technolog,.Calculate the ) and @;E for theCalculate the ) and @;E for thepro(ect.pro(ect.
)s it still accepta&le)s it still accepta&le
;;
;ro&lem 1&;ro&lem 1&
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Terminal Cash lo!Terminal Cash lo! ::
al'age 'alueal'age 'alue
?D- Tax effects of capital gainDloss?D- Tax effects of capital gainDloss
?? ecapture of net wor+ing capitale capture of net wor+ing capital
Terminal Cash FlowTerminal Cash Flow
;ro&lem 1&;ro&lem 1&
;ro&lem 1&;ro&lem 1&
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Terminal Cash lo!Terminal Cash lo! ::
al'age 'alue al'age 'alue $1""!"""$1""!""" ..
Boo+ 'alue deprecia&le asset - totalBoo+ 'alue deprecia&le asset - totalamount depreciated.amount depreciated.Boo+ 'alue $18 !""".Boo+ 'alue $18 !""".
Capital loss E - BE 7$8 !"""3Capital loss E - BE 7$8 !"""3 ..Tax refund 8 !""" x ./* Tax refund 8 !""" x ./* $2/!12"$2/!12" ..
;ro&lem 1&;ro&lem 1&
;ro&lem 1&;ro&lem 1&
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Terminal Cash lo!Terminal Cash lo! ::
1""!""" al'age 'alue1""!""" al'age 'alue
2/!12" Tax on capital gain2/!12" Tax on capital gain
2 !"""2 !""" ecapture of @%C ecapture of @%C
1* !12" Terminal Cash Flow1* !12" Terminal Cash Flow
;ro&lem 1&;ro&lem 1&
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;ro&lem 1& olution;ro&lem 1& olution
"P# and I$$: "P# and I$$:
CF7"3 -** !""".CF7"3 -** !""".
CF713! 723 18"! 8".CF713! 723 18"! 8".
CF7/3 18"! 8" ? 1* !12" /" !8 ".CF7/3 18"! 8" ? 1* !12" /" !8 ".
6iscount rate 120.6iscount rate 120.) 1 ./0) 1 ./0 ..
@;E $*8!"8 . 9ccept the pro(ectL@;E $*8!"8 . 9ccept the pro(ectL
%utomation Project %utomation Pro
ject :: ;ro&lem 2;ro&lem 2
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Cost of eHuipment Cost of eHuipment $ "!"""$ "!""" ..
hipping N installation will &ehipping N installation will &e $2 !"""$2 !""" ..
$1 !"""$1 !""" in net wor+ing capital reHuired at setup.in net wor+ing capital reHuired at setup.
-,ear pro(ect life! -,ear class life.-,ear pro(ect life! -,ear class life.
implified straight line depreciation.implified straight line depreciation.Current operating expenses areCurrent operating expenses are $8*"!"""$8*"!""" per ,r.per ,r.
@ew operating expenses will &e@ew operating expenses will &e $*""!"""$*""!""" per ,r.per ,r.
9lread, paid consultant9lread, paid consultant $2 !"""$2 !""" for anal,sis.for anal,sis.al'age 'alue after ,ear isal'age 'alue after ,ear is $*"!"""$*"!""" ..
Cost of capital Cost of capital 1*0!1*0! marginal tax rate marginal tax rate /*0/*0 ..
;
l&l 2
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;ro&lem 2;ro&lem 2 Initial Outlay Initial Outl ay ::
7 "!"""37 "!"""3 Cost of new machineCost of new machine
? 7? 7 2 !"""2 !""" 33 hipping N installationhipping N installation 7 !"""37 !"""3 6eprecia&le asset6eprecia&le asset
? 7? 7 1 !"""31 !"""3 @%C in'estment@%C in'estment 7 "!"""37 "!"""3 @et )nitial Outla,@et )nitial Outla,
For Aears 1 :For Aears 1 : ;ro&lem 2
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2*"!"""2*"!""" Cost decreaseCost decrease
7711 !"""11 !""" 33 6epreciation increase6epreciation increase
12 !"""12 !""" 4B)T4B)T 77*2! ""*2! "" 33 Taxes 7/*03Taxes 7/*03
2! ""2! "" 49T49T
11 !"""11 !""" 6epreciation re'ersal6epreciation re'ersal
1 ! "" 9nnual Cash Flow1 ! "" 9nnual Cash Flow
For Aears 1 - :For Aears 1 - : ;ro&lem 2
8 ;ro&lem 2
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2*"!"""2*"!""" Cost decreaseCost decrease
7 "37 "3 6epreciation increase6epreciation increase
2*"!"""2*"!""" 4B)T4B)T 7 1!8""37 1!8""3 Taxes 7/*03Taxes 7/*03
1 !*""1 !*"" 49T49T
"" 6epreciation re'ersal6epreciation re'ersal
1 !*"" 9nnual Cash Flow1 !*"" 9nnual Cash Flow
For Aears 8 - :For Aears 8 - : ;ro&lem 2
;ro&lem 2
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Terminal Cash lo!Terminal Cash lo! ::
*"!""" al'age 'alue*"!""" al'age 'alue
71/!8""3 Tax on capital gain71/!8""3 Tax on capital gain 1 !"""1 !""" ecapture of @%C ecapture of @%C
*1!*"" Terminal Cash Flow*1!*"" Terminal Cash Flow
;ro&lem 2
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;ro&lem /;ro&lem /
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$eplacement Project $e placement Project ::Old %sset &' years old(:Old %s set &' years old(:
Cost of eHuipment Cost of eHuipment $1!12 !"""$1!12 !""" ..
1"-,ear pro(ect life! 1"-,ear class life.1"-,ear pro(ect life! 1"-,ear class life.
implified straight line depreciation.implified straight line depreciation.
Current sal'age 'alue isCurrent sal'age 'alue is $*""!""".$*""!""".Cost of capital Cost of capital 1*0!1*0! marginal taxmarginal taxrate rate / 0./ 0.
$eplacement Project $
eplacement Project :: ;ro&lem /;ro&lem /
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"e! %sset:"e! %sset:Cost of eHuipment Cost of eHuipment $1! "!""".$1! "!""".
hipping N installation will &ehipping N installation will &e $ 8!""".$ 8!""".
$8 !"""$8 !""" in'estment in net wor+ing capital.in'estment in net wor+ing capital.
-,ear pro(ect life! -,ear class life.-,ear pro(ect life! -,ear class life.implified straight line depreciation.implified straight line depreciation.
%ill increase sales &,%ill increase sales &, $2 !"""$2 !""" per ,ear.per ,ear.
Operating expenses will fall &,Operating expenses will fall &, $1""!"""$1""!""" per ,ear.per ,ear.9lread, paid9lread, paid $1 !"""$1 !""" for training program.for training program.
al'age 'alue after ,ear isal'age 'alue after ,ear is $ ""!""".$ ""!""".
Cost of capitalCost of capital 1*0!1*0! marginal tax ratemarginal tax rate /*0./*0.
;ro&lem /: ell the Old 9sset;ro&lem /: ell the Old 9sset
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al'age 'alue al'age 'alue $*""!"""$*""!""" ..
Boo+ 'alue deprecia&le asset - totalBoo+ 'alue deprecia&le asset - totalamount depreciated.amount depreciated.
Boo+ 'alue $1!12 !""" - $ 82! ""Boo+ 'alue $1!12 !""" - $ 82! "" $ 82! "". $ 82! "".
Capital gain E - BECapital gain E - BE
*""!""" - 82! "" 7$182! ""3 *""!""" - 82! "" 7$182! ""3 ..
Tax refund 182! "" x ./ Tax refund 182! "" x ./ $ 8!$ 8! ..
;ro&lem /;ro&lem /
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;ro&lem /;ro&lem / Initial Outlay Initial Out lay ::
71! "!"""371! "!"""3 Cost of new machineCost of new machine
? 7? 7 8!""" 8!""" 33 hipping N installationhipping N installation
71! "8!"""371! "8!"""3 6eprecia&le asset6eprecia&le asset? 7 8 !"""3? 7 8 !"""3 @%C in'estment@%C in'estment
?? * 8! * 8! 9fter-tax proceeds 7sold9fter-tax proceeds 7soldold machine3old machine3
71!*1 !12 371!*1 !12 3 @et )nitial Outla,@et )nitial Outla,
;ro&lem /
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/ !"""/ !""" )ncreased sales N cost sa'ings)ncreased sales N cost sa'ings
72* ! ""372* ! ""3 4xtra depreciation4xtra depreciation
1/8!/""1/8!/"" 4BT4BT
7* ! " 37* ! " 3 Taxes 7/ 03Taxes 7/ 03
!! 49T49T 2* ! ""2* ! "" 6epreciation re'ersal6epreciation re'ersal
// !2 6ifferential Cash Flow// !2 6ifferential Cash Flow
For Aears 1 - :For Aears 1 - :;ro&lem /
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;ro&lem / olution;ro&lem / olution
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;ro&lem / olution;ro&lem / olution
"P# and I$$: "P# and I$$:CF7"3 -1!*1 !12 .CF7"3 -1!*1 !12 .
CF71 - *3 // !2 .CF71 - *3 // !2 .
CF7 3 // !2 ? / /!""" /"!2 .CF7 3 // !2 ? / /!""" /"!2 .
6iscount rate 1*0.6iscount rate 1*0.
@;E 7 !" 2." 3@;E 7 !" 2." 3 ..) 12. 0) 12. 0 ..
%e would%e would notnot accept the pro(ectLaccept the pro(ectL