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12-1 
CChhaapptteerr 1122 
CCaappiittaall BBuuddggeettiinngg 
aanndd EEssttiimmaattiinngg 
CCaasshh FFlloowwss
12-2 
WWhhaatt iiss 
CCaappiittaall BBuuddggeettiinngg?? 
The process of identifying, 
analyzing, and selecting 
investment projects whose 
returns (cash flows) are 
expected to extend beyond 
one year.
12-3 
TThhee CCaappiittaall 
BBuuddggeettiinngg PPrroocceessss 
 Generate investment proposals 
consistent with the firm’s strategic 
objectives. 
 Estimate after-tax incremental 
operating cash flows for the 
investment projects. 
 Evaluate project incremental cash 
flows.
12-4 
TThhee CCaappiittaall 
BBuuddggeettiinngg PPrroocceessss 
 Select projects based on a value-maximizing 
acceptance criterion. 
 Reevaluate implemented 
investment projects continually 
and perform postaudits for 
completed projects.
12-5 
CCllaassssiiffiiccaattiioonn ooff IInnvveessttmmeenntt 
PPrroojjeecctt PPrrooppoossaallss 
1. New products or expansion of 
existing products 
2. Replacement of existing equipment or 
buildings 
3. Research and development 
4. Exploration 
5. Other (e.g., safety or pollution related)
12-6 
SSccrreeeenniinngg PPrrooppoossaallss 
aanndd DDeecciissiioonn MMaakkiinngg 
1. Section Chiefs 
2. Plant Managers 
3. VP for Operations 
4. Capital Expenditures 
Committee 
5. President 
6. Board of Directors 
AAddvvaanncceemmeenntt 
ttoo tthhee nneexxtt 
lleevveell ddeeppeennddss 
oonn ccoosstt 
aanndd ssttrraatteeggiicc 
iimmppoorrttaannccee..
12-7 
EEssttiimmaattiinngg AAfftteerr--TTaaxx 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
BBaassiicc cchhaarraacctteerriissttiiccss ooff 
rreelleevvaanntt pprroojjeecctt fflloowwss 
 CCaasshh (not accounting income) fflloowwss 
 OOppeerraattiinngg (not financing) fflloowwss 
 AAfftteerr--ttaaxx fflloowwss 
 IInnccrreemmeennttaall fflloowwss
12-8 
EEssttiimmaattiinngg AAfftteerr--TTaaxx 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
PPrriinncciipplleess tthhaatt mmuusstt bbee aaddhheerreedd 
ttoo iinn tthhee eessttiimmaattiioonn 
 Ignore ssuunnkk ccoossttss 
 Include ooppppoorrttuunniittyy ccoossttss 
 Include project-driven cchhaannggeess iinn 
wwoorrkkiinngg ccaappiittaall net of spontaneous 
changes in current liabilities 
 Include eeffffeeccttss ooff iinnffllaattiioonn
12-9 
TTaaxx CCoonnssiiddeerraattiioonnss 
aanndd DDeepprreecciiaattiioonn 
DDeepprreecciiaattiioonn represents the systematic 
allocation of the cost of a capital asset 
over a period of time for financial 
reporting purposes, tax purposes, or 
both. 
 Generally, profitable firms prefer to use 
an accelerated method for tax 
reporting purposes (MACRS).
12-10 
DDeepprreecciiaattiioonn aanndd tthhee 
MMAACCRRSS MMeetthhoodd 
 Everything else equal, the greater the 
depreciation charges, the lower the 
taxes paid by the firm. 
 Depreciation is a noncash expense. 
 Assets are depreciated (MACRS) on one 
of eight different property classes. 
 Generally, the half-year convention is 
used for MACRS.
12-11 
MMAACCRRSS SSaammppllee SScchheedduullee 
Recovery Property Class 
Year 3-Year 5-Year 7-Year 
1 33.33% 20.00% 14.29% 
2 44.45 32.00 24.49 
3 14.81 19.20 17.49 
4 7.41 11.52 12.49 
5 11.52 8.93 
6 5.76 8.92 
7 8.93 
8 4.46
12-12 
CCaallccuullaattiinngg tthhee 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
IInniittiiaall ccaasshh oouuttffllooww -- the initial net cash 
investment. 
IInntteerriimm iinnccrreemmeennttaall nneett ccaasshh fflloowwss -- 
those net cash flows occurring after the 
initial cash investment but not including 
the final period’s cash flow. 
TTeerrmmiinnaall--yyeeaarr iinnccrreemmeennttaall nneett ccaasshh 
fflloowwss -- the final period’s net cash flow.
12-13 
IInniittiiaall CCaasshh OOuuttffllooww 
a) CCoosstt ooff ““nneeww”” aasssseettss 
b) + Capitalized expenditures 
c) + Increased NWC 
d) - Net proceeds from sale of 
“old” asset(s) if replacement 
e) + (-) Taxes (savings) due to the sale 
of “old” asset(s) if replacement 
f) == IInniittiiaall ccaasshh oouuttffllooww
12-14 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
a) Net incr. (decr.) in operating revenue 
less (plus) any net incr. (decr.) in 
operating expenses, excluding depr. 
b) - (+) Net incr. (decr.) in tax depreciation 
c) = Net change in income before taxes 
d) - (+) Net incr. (decr.) in taxes 
e) = Net change in income after taxes 
f) + (-) Net incr. (decr.) in tax depr. charges 
g) == IInnccrreemmeennttaall nneett ccaasshh ffllooww ffoorr ppeerriioodd
12-15 
TTeerrmmiinnaall--YYeeaarr 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
a) Calculate the iinnccrreemmeennttaall nneett ccaasshh 
ffllooww for the tteerrmmiinnaall ppeerriioodd 
b) + (-) Salvage value (disposal/reclamation 
costs) of any sold or disposed assets 
c) - (+) Taxes (tax savings) due to asset sale 
or disposal of “new” assets 
d) + (-) Decreased (increased) level of “net” 
working capital 
e) == TTeerrmmiinnaall yyeeaarr iinnccrreemmeennttaall nneett ccaasshh ffllooww
12-16 
Example 1: aann AAsssseett EExxppaannssiioonn PPrroojjeecctt 
 ABC Co. is considering the purchase of a new 
equipment. The equipment will cost $90,000 plus 
$10,000 for shipping and installation. 
 Falls under the 3-year MACRS class. 
 No NWC requirements. 
 It is forecasted that revenues for the next 4 years : 
35167, 36250, 55725, 32,258. 
 The used equipment will then be sold (scrapped) for 
$16,500 at the end of the fourth year, when the project 
ends. 
 It is in the 40% tax bracket.
12-17 
IInniittiiaall CCaasshh OOuuttffllooww 
a) $90,000 
b) + 10,000 
c) + 0 
d - 0 (not a replacement) 
e) + (-) 0 (not a replacement) 
f) == $$110000,,000000
12-18 
EExxaammppllee 11:: aann AAsssseett 
EExxppaannssiioonn PPrroojjeecctt 
year 1 year 2 year 3 year 4 
a) Net C/F 35167 36250 55725 32258 
b) - Depr. 33330 44450 14810 7410 
c) = CF_BT 1837 (8200) 40915 24848 
d) - Tax 735 (3280) 16366 9939 
e) = CF_AT 1102 (4920) 24549 14909 
f) + Depr. 33330 44450 14810 7410 
g) Incr. C/F 34432 39530 39359 22319 
or (a) - (d) 34432 39530 39359 22319
TTeerrmmiinnaall--YYeeaarr IInnccrreemmeennttaall CC//FF 
12-19 
a) $$2222,,331199 The iinnccrreemmeennttaall ccaasshh ffllooww 
from the previous slide in Year 4. 
b) + 16,500 Salvage Value. 
c) - 6,600 .40*($16,500 - 0) Note, the 
asset is fully depreciated at 
the end of Year 4. 
d) + 0 NWC - Project ends. 
e) == $$3322,,221199 TTeerrmmiinnaall--yyeeaarr iinnccrreemmeennttaall 
ccaasshh ffllooww..
12-20 
SSuummmmaarryy ooff PPrroojjeecctt NNeett CCaasshh 
FFlloowwss 
Asset Expansion 
Year 0 Year 1 Year 2 Year 3 
Year 4 
--$$110000,,000000 $$3344,,443322 $$3399,,553300 $$3399,,335599 
$$3322,,221199
12-21 
SSuummmmaarryy ooff PPrroojjeecctt 
year 1 year 2 year 3 year 4 
a) Net C/F 35167 36250 55725 32258 
b) - Depr. 33330 44450 14810 7410 
c) = CF_BT 1837 (8200) 40915 24848 
d) - Tax 735 (3280) 16366 9939 
(a) - (d) 34432 39530 39359 22319 
Terminal Year CF = (16,500*.6)=9,900 32,219 
(100000) 34,432 39,530 39,359 32,219
EExxaammppllee 22:: aann AAsssseett EExxppaannssiioonn PPrroojjeecctt 
BW Co. is considering the purchase of a new machine. 
The machine will cost $50,000 plus $20,000 for shipping 
and installation. 
Falls under the 3-year MACRS class. 
NWC will rise by $5,000. 
FM forecasts that revenues will increase by $110,000 for 
each of the next 4 years and will then be sold (scrapped) 
for $10,000 at the end of the fourth year, when the project 
ends. Operating costs will rise by $70,000 for each of the 
next four years. 
BW is in the 40% tax bracket. 
12-22
12-23 
IInniittiiaall CCaasshh OOuuttffllooww 
a) $50,000 
b) + 20,000 
c) + 5,000 
d) - 0 (not a replacement) 
e) + (-) 0 (not a replacement) 
f) == $$7755,,000000
12-24 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
Year 1 Year 2 Year 3 Year 4 
a) Net C/F $40,000 $40,000 $40,000 $40,000 
b) - Depr. 23,331 31,115 10,367 5,187 
c) = CF_BT $16,669 $ 8,885 $29,633 $34,813 
d) - Tax 6,668 3,554 11,853 13,925 
e) = CF_AT $10,001 $ 5,331 $17,780 $20,888 
f) + 23,331 31,115 10,367 5,187 
g) == $$3333,,333322 $$3366,,444466 $$2288,,114477 $$2266,,007755
12-25 
TTeerrmmiinnaall--YYeeaarr 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
a) $$2266,,007755 The iinnccrreemmeennttaall ccaasshh ffllooww 
from the previous slide in 
Year 4. 
b) + 10,000 Salvage Value. 
c) - 4,000 .40*($10,000 - 0) Note, the 
asset is fully depreciated at 
the end of Year 4. 
d) + 5,000 NWC - Project ends. 
e) == $$3377,,007755 TTeerrmmiinnaall--yyeeaarr iinnccrreemmeennttaall 
ccaasshh ffllooww..
12-26 
SSuummmmaarryy ooff PPrroojjeecctt 
NNeett CCaasshh FFlloowwss 
Asset Expansion 
Year 0 Year 1 Year 2 Year 3 Year 4 
--$$7755,,000000** $$3333,,333322 $$3366,,444466 $$2288,,114477 $$3377,,007755 
* Notice again that this value is a nneeggaattiivvee 
cash flow as we calculated it as the initial 
cash OUTFLOW
o Example off aann AAsssseett RReeppllaacceemmeenntt PPrroojjeecctt 
Let us assume that previous asset expansion project is 
actually an asset replacement project. 
The new machine will cost $50,000 plus $20,000 for 
shipping and installation and falls under the 3-year MACRS 
class. 
The original basis of the old machine was $30,000 and 
depreciated using straight-line over five years ($6,000 per 
year). The machine has two years of depreciation and four 
years of useful life remaining. BW can sell the current 
machine for $6,000. The new machine will save $10,000 per 
year. 
NWC are $5,000. 
40% tax bracket. 
12-27
12-28 
IInniittiiaall CCaasshh OOuuttffllooww 
a) $50,000 Cost 
b) + 20,000 Shipping + installation 
= $$7700,,000000 DDeepprreecciiaabbllee bbaassiiss 
c) + 5,000 NWC 
d) - 6,000 (sale of “old” asset) 
e) - 2,400 --- 
(tax savings 
f) == $$6666,,660000 
from 
loss on sale of 
“old” asset)
12-29 
Depreciable Basis (old) 30000 
Remaining life 4 years 
Remaining depr. 2 years 
Acc. Depr. (3-yaers) 18000 
Book Value 12000 
Sold for 6000 
Loss on disposal 6000 
Tax saving 2400
12-30 
CCaallccuullaattiioonn ooff tthhee 
CChhaannggee iinn DDeepprreecciiaattiioonn 
Year 1 Year 2 Year 3 Year 4 
a) $23,331 $31,115 $10,367 $ 5,187 
b) - 6,000 6,000 0 0 
c) = $$1177,,333311 $$2255,,111155 $$1100,,336677 $$ 55,,118877 
a) Represent the depreciation on the “new” 
project. 
b) Represent the remaining depreciation on the 
“old” project. 
c) Net cchhaannggee in tax depreciation charges.
12-31 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
Year 1 Year 2 Year 3 Year 4 
a) Net C/F $10,000 $10,000 $10,000 $10,000 
b) - Depr. (net) 1177,,333311 2255,,111155 1100,,336677 55,,118877 
c) = CF_BT $ -7,331 -$15,115 $ -367 $ 4,813 
d) - tax -2,932 -6,046 -147 1,925 
g) == $$1122,,993322 $$1166,,004466 $$1100,,114477 $$ 88,,007755
12-32 
TTeerrmmiinnaall--YYeeaarr 
IInnccrreemmeennttaall CCaasshh FFlloowwss 
a) $$ 88,,007755 The iinnccrreemmeennttaall ccaasshh ffllooww 
from the previous slide in 
Year 4. 
b) + 10,000 Salvage Value. 
c) - 4,000 (.40)*($10,000). Note, the 
asset is fully depreciated at 
the end of Year 4. 
d) + 5,000 Return of “added” NWC. 
e) == $$1199,,007755 TTeerrmmiinnaall--yyeeaarr iinnccrreemmeennttaall 
ccaasshh ffllooww.
12-33 
SSuummmmaarryy ooff PPrroojjeecctt 
NNeett CCaasshh FFlloowwss 
Asset Expansion 
Year 0 Year 1 Year 2 Year 3 Year 4 
--$$7755,,000000 $$3333,,333322 $$3366,,444466 $$2288,,114477 $$3377,,007755 
Asset Replacement 
Year 0 Year 1 Year 2 Year 3 Year 4 
--$$6666,,660000 $$1122,,993333 $$1166,,004466 $$1100,,114477 $$1199,,007755

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Estimation of cash flows

  • 1. 12-1 CChhaapptteerr 1122 CCaappiittaall BBuuddggeettiinngg aanndd EEssttiimmaattiinngg CCaasshh FFlloowwss
  • 2. 12-2 WWhhaatt iiss CCaappiittaall BBuuddggeettiinngg?? The process of identifying, analyzing, and selecting investment projects whose returns (cash flows) are expected to extend beyond one year.
  • 3. 12-3 TThhee CCaappiittaall BBuuddggeettiinngg PPrroocceessss Generate investment proposals consistent with the firm’s strategic objectives. Estimate after-tax incremental operating cash flows for the investment projects. Evaluate project incremental cash flows.
  • 4. 12-4 TThhee CCaappiittaall BBuuddggeettiinngg PPrroocceessss Select projects based on a value-maximizing acceptance criterion. Reevaluate implemented investment projects continually and perform postaudits for completed projects.
  • 5. 12-5 CCllaassssiiffiiccaattiioonn ooff IInnvveessttmmeenntt PPrroojjeecctt PPrrooppoossaallss 1. New products or expansion of existing products 2. Replacement of existing equipment or buildings 3. Research and development 4. Exploration 5. Other (e.g., safety or pollution related)
  • 6. 12-6 SSccrreeeenniinngg PPrrooppoossaallss aanndd DDeecciissiioonn MMaakkiinngg 1. Section Chiefs 2. Plant Managers 3. VP for Operations 4. Capital Expenditures Committee 5. President 6. Board of Directors AAddvvaanncceemmeenntt ttoo tthhee nneexxtt lleevveell ddeeppeennddss oonn ccoosstt aanndd ssttrraatteeggiicc iimmppoorrttaannccee..
  • 7. 12-7 EEssttiimmaattiinngg AAfftteerr--TTaaxx IInnccrreemmeennttaall CCaasshh FFlloowwss BBaassiicc cchhaarraacctteerriissttiiccss ooff rreelleevvaanntt pprroojjeecctt fflloowwss  CCaasshh (not accounting income) fflloowwss  OOppeerraattiinngg (not financing) fflloowwss  AAfftteerr--ttaaxx fflloowwss  IInnccrreemmeennttaall fflloowwss
  • 8. 12-8 EEssttiimmaattiinngg AAfftteerr--TTaaxx IInnccrreemmeennttaall CCaasshh FFlloowwss PPrriinncciipplleess tthhaatt mmuusstt bbee aaddhheerreedd ttoo iinn tthhee eessttiimmaattiioonn  Ignore ssuunnkk ccoossttss  Include ooppppoorrttuunniittyy ccoossttss  Include project-driven cchhaannggeess iinn wwoorrkkiinngg ccaappiittaall net of spontaneous changes in current liabilities  Include eeffffeeccttss ooff iinnffllaattiioonn
  • 9. 12-9 TTaaxx CCoonnssiiddeerraattiioonnss aanndd DDeepprreecciiaattiioonn DDeepprreecciiaattiioonn represents the systematic allocation of the cost of a capital asset over a period of time for financial reporting purposes, tax purposes, or both. Generally, profitable firms prefer to use an accelerated method for tax reporting purposes (MACRS).
  • 10. 12-10 DDeepprreecciiaattiioonn aanndd tthhee MMAACCRRSS MMeetthhoodd Everything else equal, the greater the depreciation charges, the lower the taxes paid by the firm. Depreciation is a noncash expense. Assets are depreciated (MACRS) on one of eight different property classes. Generally, the half-year convention is used for MACRS.
  • 11. 12-11 MMAACCRRSS SSaammppllee SScchheedduullee Recovery Property Class Year 3-Year 5-Year 7-Year 1 33.33% 20.00% 14.29% 2 44.45 32.00 24.49 3 14.81 19.20 17.49 4 7.41 11.52 12.49 5 11.52 8.93 6 5.76 8.92 7 8.93 8 4.46
  • 12. 12-12 CCaallccuullaattiinngg tthhee IInnccrreemmeennttaall CCaasshh FFlloowwss IInniittiiaall ccaasshh oouuttffllooww -- the initial net cash investment. IInntteerriimm iinnccrreemmeennttaall nneett ccaasshh fflloowwss -- those net cash flows occurring after the initial cash investment but not including the final period’s cash flow. TTeerrmmiinnaall--yyeeaarr iinnccrreemmeennttaall nneett ccaasshh fflloowwss -- the final period’s net cash flow.
  • 13. 12-13 IInniittiiaall CCaasshh OOuuttffllooww a) CCoosstt ooff ““nneeww”” aasssseettss b) + Capitalized expenditures c) + Increased NWC d) - Net proceeds from sale of “old” asset(s) if replacement e) + (-) Taxes (savings) due to the sale of “old” asset(s) if replacement f) == IInniittiiaall ccaasshh oouuttffllooww
  • 14. 12-14 IInnccrreemmeennttaall CCaasshh FFlloowwss a) Net incr. (decr.) in operating revenue less (plus) any net incr. (decr.) in operating expenses, excluding depr. b) - (+) Net incr. (decr.) in tax depreciation c) = Net change in income before taxes d) - (+) Net incr. (decr.) in taxes e) = Net change in income after taxes f) + (-) Net incr. (decr.) in tax depr. charges g) == IInnccrreemmeennttaall nneett ccaasshh ffllooww ffoorr ppeerriioodd
  • 15. 12-15 TTeerrmmiinnaall--YYeeaarr IInnccrreemmeennttaall CCaasshh FFlloowwss a) Calculate the iinnccrreemmeennttaall nneett ccaasshh ffllooww for the tteerrmmiinnaall ppeerriioodd b) + (-) Salvage value (disposal/reclamation costs) of any sold or disposed assets c) - (+) Taxes (tax savings) due to asset sale or disposal of “new” assets d) + (-) Decreased (increased) level of “net” working capital e) == TTeerrmmiinnaall yyeeaarr iinnccrreemmeennttaall nneett ccaasshh ffllooww
  • 16. 12-16 Example 1: aann AAsssseett EExxppaannssiioonn PPrroojjeecctt  ABC Co. is considering the purchase of a new equipment. The equipment will cost $90,000 plus $10,000 for shipping and installation.  Falls under the 3-year MACRS class.  No NWC requirements.  It is forecasted that revenues for the next 4 years : 35167, 36250, 55725, 32,258.  The used equipment will then be sold (scrapped) for $16,500 at the end of the fourth year, when the project ends.  It is in the 40% tax bracket.
  • 17. 12-17 IInniittiiaall CCaasshh OOuuttffllooww a) $90,000 b) + 10,000 c) + 0 d - 0 (not a replacement) e) + (-) 0 (not a replacement) f) == $$110000,,000000
  • 18. 12-18 EExxaammppllee 11:: aann AAsssseett EExxppaannssiioonn PPrroojjeecctt year 1 year 2 year 3 year 4 a) Net C/F 35167 36250 55725 32258 b) - Depr. 33330 44450 14810 7410 c) = CF_BT 1837 (8200) 40915 24848 d) - Tax 735 (3280) 16366 9939 e) = CF_AT 1102 (4920) 24549 14909 f) + Depr. 33330 44450 14810 7410 g) Incr. C/F 34432 39530 39359 22319 or (a) - (d) 34432 39530 39359 22319
  • 19. TTeerrmmiinnaall--YYeeaarr IInnccrreemmeennttaall CC//FF 12-19 a) $$2222,,331199 The iinnccrreemmeennttaall ccaasshh ffllooww from the previous slide in Year 4. b) + 16,500 Salvage Value. c) - 6,600 .40*($16,500 - 0) Note, the asset is fully depreciated at the end of Year 4. d) + 0 NWC - Project ends. e) == $$3322,,221199 TTeerrmmiinnaall--yyeeaarr iinnccrreemmeennttaall ccaasshh ffllooww..
  • 20. 12-20 SSuummmmaarryy ooff PPrroojjeecctt NNeett CCaasshh FFlloowwss Asset Expansion Year 0 Year 1 Year 2 Year 3 Year 4 --$$110000,,000000 $$3344,,443322 $$3399,,553300 $$3399,,335599 $$3322,,221199
  • 21. 12-21 SSuummmmaarryy ooff PPrroojjeecctt year 1 year 2 year 3 year 4 a) Net C/F 35167 36250 55725 32258 b) - Depr. 33330 44450 14810 7410 c) = CF_BT 1837 (8200) 40915 24848 d) - Tax 735 (3280) 16366 9939 (a) - (d) 34432 39530 39359 22319 Terminal Year CF = (16,500*.6)=9,900 32,219 (100000) 34,432 39,530 39,359 32,219
  • 22. EExxaammppllee 22:: aann AAsssseett EExxppaannssiioonn PPrroojjeecctt BW Co. is considering the purchase of a new machine. The machine will cost $50,000 plus $20,000 for shipping and installation. Falls under the 3-year MACRS class. NWC will rise by $5,000. FM forecasts that revenues will increase by $110,000 for each of the next 4 years and will then be sold (scrapped) for $10,000 at the end of the fourth year, when the project ends. Operating costs will rise by $70,000 for each of the next four years. BW is in the 40% tax bracket. 12-22
  • 23. 12-23 IInniittiiaall CCaasshh OOuuttffllooww a) $50,000 b) + 20,000 c) + 5,000 d) - 0 (not a replacement) e) + (-) 0 (not a replacement) f) == $$7755,,000000
  • 24. 12-24 IInnccrreemmeennttaall CCaasshh FFlloowwss Year 1 Year 2 Year 3 Year 4 a) Net C/F $40,000 $40,000 $40,000 $40,000 b) - Depr. 23,331 31,115 10,367 5,187 c) = CF_BT $16,669 $ 8,885 $29,633 $34,813 d) - Tax 6,668 3,554 11,853 13,925 e) = CF_AT $10,001 $ 5,331 $17,780 $20,888 f) + 23,331 31,115 10,367 5,187 g) == $$3333,,333322 $$3366,,444466 $$2288,,114477 $$2266,,007755
  • 25. 12-25 TTeerrmmiinnaall--YYeeaarr IInnccrreemmeennttaall CCaasshh FFlloowwss a) $$2266,,007755 The iinnccrreemmeennttaall ccaasshh ffllooww from the previous slide in Year 4. b) + 10,000 Salvage Value. c) - 4,000 .40*($10,000 - 0) Note, the asset is fully depreciated at the end of Year 4. d) + 5,000 NWC - Project ends. e) == $$3377,,007755 TTeerrmmiinnaall--yyeeaarr iinnccrreemmeennttaall ccaasshh ffllooww..
  • 26. 12-26 SSuummmmaarryy ooff PPrroojjeecctt NNeett CCaasshh FFlloowwss Asset Expansion Year 0 Year 1 Year 2 Year 3 Year 4 --$$7755,,000000** $$3333,,333322 $$3366,,444466 $$2288,,114477 $$3377,,007755 * Notice again that this value is a nneeggaattiivvee cash flow as we calculated it as the initial cash OUTFLOW
  • 27. o Example off aann AAsssseett RReeppllaacceemmeenntt PPrroojjeecctt Let us assume that previous asset expansion project is actually an asset replacement project. The new machine will cost $50,000 plus $20,000 for shipping and installation and falls under the 3-year MACRS class. The original basis of the old machine was $30,000 and depreciated using straight-line over five years ($6,000 per year). The machine has two years of depreciation and four years of useful life remaining. BW can sell the current machine for $6,000. The new machine will save $10,000 per year. NWC are $5,000. 40% tax bracket. 12-27
  • 28. 12-28 IInniittiiaall CCaasshh OOuuttffllooww a) $50,000 Cost b) + 20,000 Shipping + installation = $$7700,,000000 DDeepprreecciiaabbllee bbaassiiss c) + 5,000 NWC d) - 6,000 (sale of “old” asset) e) - 2,400 --- (tax savings f) == $$6666,,660000 from loss on sale of “old” asset)
  • 29. 12-29 Depreciable Basis (old) 30000 Remaining life 4 years Remaining depr. 2 years Acc. Depr. (3-yaers) 18000 Book Value 12000 Sold for 6000 Loss on disposal 6000 Tax saving 2400
  • 30. 12-30 CCaallccuullaattiioonn ooff tthhee CChhaannggee iinn DDeepprreecciiaattiioonn Year 1 Year 2 Year 3 Year 4 a) $23,331 $31,115 $10,367 $ 5,187 b) - 6,000 6,000 0 0 c) = $$1177,,333311 $$2255,,111155 $$1100,,336677 $$ 55,,118877 a) Represent the depreciation on the “new” project. b) Represent the remaining depreciation on the “old” project. c) Net cchhaannggee in tax depreciation charges.
  • 31. 12-31 IInnccrreemmeennttaall CCaasshh FFlloowwss Year 1 Year 2 Year 3 Year 4 a) Net C/F $10,000 $10,000 $10,000 $10,000 b) - Depr. (net) 1177,,333311 2255,,111155 1100,,336677 55,,118877 c) = CF_BT $ -7,331 -$15,115 $ -367 $ 4,813 d) - tax -2,932 -6,046 -147 1,925 g) == $$1122,,993322 $$1166,,004466 $$1100,,114477 $$ 88,,007755
  • 32. 12-32 TTeerrmmiinnaall--YYeeaarr IInnccrreemmeennttaall CCaasshh FFlloowwss a) $$ 88,,007755 The iinnccrreemmeennttaall ccaasshh ffllooww from the previous slide in Year 4. b) + 10,000 Salvage Value. c) - 4,000 (.40)*($10,000). Note, the asset is fully depreciated at the end of Year 4. d) + 5,000 Return of “added” NWC. e) == $$1199,,007755 TTeerrmmiinnaall--yyeeaarr iinnccrreemmeennttaall ccaasshh ffllooww.
  • 33. 12-33 SSuummmmaarryy ooff PPrroojjeecctt NNeett CCaasshh FFlloowwss Asset Expansion Year 0 Year 1 Year 2 Year 3 Year 4 --$$7755,,000000 $$3333,,333322 $$3366,,444466 $$2288,,114477 $$3377,,007755 Asset Replacement Year 0 Year 1 Year 2 Year 3 Year 4 --$$6666,,660000 $$1122,,993333 $$1166,,004466 $$1100,,114477 $$1199,,007755