Task 4 - Resume Making Capital Investment Decisions.pptx

Task 4 - Resume Making Capital Investment Decisions.pptx

• 1.
  MAKING CAPITAL INVESTMENT DECISIONS ZALFA KARINA 242221059
• 2.
  PROJECT CASH FLOWS RELEVANTCASH FLOW A relevant cash flow for a project is a change in the firm’s overall future cash flow that comes about as a direct consequence of the decision to take that project. The incremental cash flows for project evaluation consist of any and all changes in the firm’s future cash flows that are a direct consequence of taking the project. THE STAND-ALONE PRINCIPLE Identification the effect of undertaking the proposed project on the firm’s cash flows, and focus only on the project’s resulting incremental cash flows.
• 3.
  SOME SITUATIONS OFINCREMENTAL CASH FLOW SUNK COST A cost that has already been incurred and cannot be removed and therefore should not be considered in an investment decision. OPPORTUNITY COSTS The most valuable alternative that is given up if a particular investment is undertaken. SIDE EFFECTS Side effects show up in a lot of different ways. It would not be unusual for a project to have side, or spillover, effects, both good and bad. Erosion is the cash flows of a new project that come at the expense of a firm’s existing projects. NET WORKING CAPITAL Normally a project will require that the fi rm invest in net working capital in addition to long-term assets. Some of the fi nancing for this will be in the form of amounts owed to suppliers (accounts payable), but the fi rm will have to supply the balance. This balance represents the investment in net working capital FINANCING COSTS In analyzing a proposed investment, we will not include interest paid or any other financing costs such as dividends or principal repaid because we are interested in the cash flow generated by the assets of the project
• 4.
  PRO FORMA FINANCIAL STATEMENT Financialstatements projecting future years’ operations
• 5.
  PROJECT CASH FLOW Cashflow from assets has three components: operating cash flow, capital spending, and changes in net working capital. To evaluate a project, or minifirm, we need to estimate each of these. Project Operating Cash Flow To determine the operating cash flow associated with a project, we first need to recall the definition of operating cash flow: Operating cash flow = Earnings before interest and taxes Project Net Working Capital and Capital Spending We next need to take care of the fi xed asset and net working capital requirements. On a purely mechanical level, notice that whenever we have an investment in net working capital, that same investment has to be recovered; in other words, the same number needs to appear at some time in the future with the opposite sign
• 6.
  Based on ourbalance sheets, we know that the firm must spend $90,000 up front for fixed assets and invest an additional $20,000 in net working capital. The immediate outflow is thus $110,000. At the end of the project’s life, the fixed assets will be worthless, but the firm will recover the $20,000 that was tied up in working capital.6 This will lead to a $20,000 inflow in the last year. The net income each year is $21,780. The average (in thousands) of the four book values (from Table 10.2) for total investment is ($110 1 80 1 50 1 20)y4 5 $65. So the AAR is $21,780y65,000 5 33.51 percent.8 We’ve already seen that the return on this investment (the IRR) is about 26 percent. The fact that the AAR is larger illustrates again why the AAR cannot be meaningfully interpreted as the return on a project
• 7.
  Cash Collections andCosts
• 8.
  As we noteelsewhere, accounting depreciation is a noncash deduction. As a result, depreciation has cash flow consequences only because it influences the tax bill. The way that depreciation is computed for tax purposes is thus the relevant method for capital investment decisions. Accelerated cost recovery system (ACRS) A depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifi cations.  Modified ACRS Depreciation (MACRS) the basic idea under MACRS is that every asset is assigned to a particular class. An asset’s class establishes its life for tax purposes. PROJECT CASH FLOW
• 9.
  PROJECT CASH FLOW Book Value versus Market Value In calculating depreciation under current tax law, the economic life and future market value of the asset are not an issue. As a result, the book value of an asset can differ substantially from its actual market value. For example, with our $12,000 car, book value after the first year is $12,000 less the first year’s depreciation of $2,400, or $9,600. The remaining book values are summarized in Table. After six years, the book value of the car is zero Finally, if the book value exceeds the market value, then the difference is treated as a loss for tax purposes. For example, if we sell the car after two years for $4,000, then the book value exceeds the market value by $1,760. In this case, a tax saving of .34 3 $1,760 5 $598.40 occurs.
• 10.
  AN EXAMPLE: THEMAJESTIC MULCH AND COMPOST COMPANY MMCC projects unit sales as follows
• 13.
  Capital Spending :MMCC invests $800,000 at Year 0. By assumption, this equipment will be worth $160,000 at the end of the project. It will have a book value of zero at that time. As we discussed earlier, this $160,000 excess of market value over book value value is taxable, so the aftertax proceeds will be $160,000 x (1 - .34) = $105,60 Total Cash Flow and Value : As indicated, the fractional year works out to be $17,322/214,040 = .08, so the payback is 4.08 years. We can’t say whether or not this is good because we don’t have a benchmark for MMCC. This is the usual problem with payback periods. Conclusion : MMCC should begin production and marketing immediately. It is unlikely that this will be the case. It is important to remember that the result of our analysis is an estimate of NPV, and we will usually have less than complete confi dence in our projections. This means we have more work to do
• 14.
  Alternative Definitions ofOperating Cash Flow  THE BOTTOM-UP APPROACH : berfokus pada analisa atas masing-masing saham. Dengan pendekatan ini, manajer investasi tidak memfokuskan perhatiannya pada sektor industri atau kondisi perekonomian secara keseluruhan, melainkan pada satu-persatu emiten.  THE TOP-DOWN APPROACH : pendekatan analisa fundamental dimulai dari faktor fundamental yang paling besar, yaitu menganalisa kondisi makro ekonomi, kemudian diikuti dengan analisis sektoral dan terakhir melakukan analisis dalam konteks yang lebih mikro, yaitu analisa perusahaan secara spesifik  THE TAX SHIELD APPROACH : proses jumlah pengurangan penghasilan kena pajak untuk suatu perusahaan atau individu dicapai dengan mengklaim pengurangan diperbolehkan seperti biaya pengobatan, amortisasi, pinjaman atau utang, bunga hipotek, depresiasi dan sumbangan amal
• 15.
  • Sales =$1,500 • Costs = $700 • Depreciation = $600 With these estimates, notice that EBIT is: • EBIT = Sales - Costs - Depreciation = $1,500 - 700 - 600 = $200 Once again, we assume that no interest is paid, so the tax bill is: • Taxes = EBIT x T = $200 x .34 = $68 When we put all of this together, • OCF = EBIT + Depreciation − Taxes = $200 + 600 - 68 = $732 Calculate Operating Cash Flow
• 16.
  BOTTOM – UPAPPROACH Because we are ignoring any financing expenses, such as interest, in our calculations of project Project net income = EBIT - Taxes = $200 - 68 = $132 If we simply add the depreciation to both sides, we arrive at a slightly different and very common expression for OCF: OCF = Net income + Depreciation = $132 + 600 = $732 This is the bottom-up approach. Here, we start with the accountant’s bottom line (net income) and add back any noncash deductions such as depreciation. For the shark attractant project, net income was $21,780 and depreciation was $30,000, so the bottom-up result is $51,780 TOP – DOWN APPROACH OCF = Sales - Costs - Taxes = $1,500 - 700 - 68 = $732 This is the top-down approach, the second variation on the basic OCF definition. Here, we start at the top of the income statement with sales and work our way down to net cash flow by subtracting costs, taxes, and other expenses. Along the way, we simply leave out any strictly noncash items such as depreciation. For the shark attractant project, the operating cash flow can be readily calculated using the top-down approach. With sales of $200,000, total costs (fixed plus variable) of $137,000, and a tax bill of $11,220, the OCF is $51,780 Calculate Operating Cash Flow
• 17.
  THE TAX SHIELDAPPROACH The tax shield definition of OCF is: OCF = (Sales - Costs) X (1 - T ) + Depreciation X T where T is again the corporate tax rate. Assuming that T 5 34%, the the OCF OCF = ($1,500 - 700) X .66 + 600 X .34 = $528 + 204 = $732 So, in our example, the $600 depreciation deduction saves saves us $600 X .34 = $204 in taxes. For the shark attractant project we considered earlier in the chapter, the depreciation tax shield would be $30,000 X .34 = $10,200. The aftertax value for sales less costs would be ($200,000 - 137,000) X (1 - .34) = $41,580. Adding these together yields the value of OCF: OCF : $41,580 + 10,200 = $51,780 CONCLUSION Now that we’ve seen that all of these approaches are the same, you’re probably wondering why everybody doesn’t just agree on one of them. One reason, as we will see in the next section, is that different approaches are useful in different circumstances. The best one to use is whichever happens to be the most convenient for the problem at hand. Calculate Operating Cash Flow
• 18.
  Some Special Casesof Discounted Cash Flow Analysis  EVALUATING COST-CUTTING PROPOSALS : One decision we frequently face is whether to upgrade existing facilities to make them more cost-effective. The issue is whether the cost savings are large enough to justify the necessary capital expenditure.  SETTING THE BID PRICE : we used discounted cash fl ow analysis to evaluate a proposed new product. A somewhat different (and common) scenario arises when we must submit a competitive bid to win a job. Under such circumstances, the winner is whoever submits the lowest bid.  EVALUATING EQUIPMENT OPTIONS WITH DIFFERENT LIVES : Our goal is to choose the most cost- effective. The approach we consider here is necessary only when two special circumstances exist. First, First, the possibilities under evaluation have different economic lives. Second, and just as important, we will need whatever we buy more or less indefi nitely. As a result, when it wears out, we will buy another one.
• 19.
  EXAMPLE CASE