F9FM-Session05 d08jkbn

SESSION 05 RELEVANT CASH FLOWS FOR DCF
0501
OVERVIEW
Objective
To recognise the costs that are relevant to a discounted cash flow analysis.
To be able to determine the taxation effects of a new investment.
To be able to deal with inflation using either the money method, real method or
effective method.
To do able to deal with cash flows relating to working capital.

RELEVANT
COSTS
WORKING
CAPITAL
TAXATION
General rule
Layout of cash flows
Basic effect of the UK tax
system
Timing
Other assumptions
Dealing with taxation
INFLATION

Why inflation is a problem
Real and money interest rates
General and specific inflation
rates
Cash flow forecasts
Discounting

0502
1 RELEVANT COSTS FOR DISCOUNTING
1.1 General rule
Include only those costs and revenues which are affected by the decision. This means using
only:

future;
Incremental;
operating cash flows.
Operating cash flows means the cash flows generated from operating the project e.g. cash
from sales, less operating costs such as materials and labour.
Do not include financing cash flows because the cost of finance is measured in the cost of
capital/discount rate - finance costs are taken into account by the discounting process itself.
Specifically, exclude:
sunk costs money already spent;
non-cash costs e.g. depreciation;
book values e.g. FIFO/LIFO inventory values;
unavoidable costs money already committed e.g. apportioned fixed costs;
finance costs e.g. interest (discounting the operating cash flows already deals with this).
However, include:
all opportunity costs and revenues e.g. cannibalisation; where the launch of a new
product will reduce the sales if an exiting product. The lost contribution is an
opportunity cost and should be shown as a cash outflow.
0503

Example 1

A research project, which to date has cost the company $150,000, is under
review.
If the project is allowed to proceed, it will be completed in approximately one
year, when the results would be sold to a government agency for $300,000.
Shown below are the additional expenses which the managing director
estimates will be necessary to complete the work.
Materials
This material has just been purchased at a cost of $60,000. It is toxic and, if not
used in this project, must be disposed of at a cost of $5,000.
Labour
Skilled labour is hard to recruit. The workers concerned were transferred to
the project from a production department, and at a recent meeting the
production manager claimed that if the men were returned to him they could
generate sales of $150,000 in the next year. The prime cost of these sales would
be $100,000, including $40,000 for the labour cost itself. The overhead
absorbed into this production would amount to $20,000.
Research staff
It has already been decided that, when work on this project ceases, the research
department will be closed. Research wages for the year are $60,000, and
redundancy and severance pay has been estimated at $15,000 now or $35,000 in
one years time.
Equipment
The project utilises a special microscope which cost $18,000 three years ago. It
has a residual value of $3,000 in another two years, and a current disposal
value of $8,000. If used in the project it is estimated that the disposal value in a
years time will be $6,000.
Share of general building services
The project is charged with $35,000 per annum to cover general building
expenses. Immediately the project is discontinued, the space occupied could
be sub-let for an annual rental of $7,000.
Required:
Advise the managing director as to whether the project should be allowed to
proceed, explaining the reasons for the treatment of each item.
(Ignore the time value of money.)

0504
Solution
Costs and revenues of proceeding with the project.
$
(1) Costs to date
(2) Materials

(3) Labour cost

Absorption of overheads
(4) Research staff costs
Wages
Redundancy pay

(5) Equipment

(6) General building services
Apportioned costs
Opportunity costs

_______

Sales value of project

Increased contribution from project
_______

_______

Advice:
0505
1.2 Layout of cash flows
A company invests $10,000 today in a machine. It expects to earn $7,000 per year for two
years as a result. Discount rate = 15%.
Calculate the net present value of the investment.
(i) Time Narrative Cash flow 15% Present
Discount factor/
annuity factor
0 Machine (10,000) 1 (10,000)
12 Project
income 7,000 1.626 11,382

______

NPV $1,382

______

or
(ii) 0 1 2
Machine (10,000)
Income 7,000 7,000

______

______

______

(10,000) 7,000 7,000
15% factor 1 0.870 0.756

______

______

______

Present
value (10,000) 6,090 5,292

NPV

= $1,382

______

Commentary

In complex exam questions it is usually better to present your answer using the
second format i.e. with columns for years.

0506
2 TAXATION
2.1 Basic effect of the UK tax system
Taxation has two effects in investment appraisal

Tax charged
on operating
results
Tax relief given
on non-current assets
via
WRITING DOWN
ALLOWANCES
NEGATIVE
EFFECT
POSITIVE
EFFECT

Operating results = revenues
operating costs
Any tax relief on finance costs is
taken into account in the
discount rate/cost of capital.
Depreciation expense from the financial
statements is not a tax allowable
deduction in the UK
Instead companies can claim Writing
Down Allowances (WDAs), also called
Capital Allowances (CAs)
Details:
Often given at 25% reducing balance
but exam question will tell you the
policy.
no WDA in year of sale; balancing
allowance/charge given instead,
representing a tax loss/gain on
disposal.

0507
2.2 Timing
The timing of tax cash flows is complex. Some exam questions will tell you that tax is paid
in the year of taxable profits, other questions will tell you tax is paid "one year in arrears i.e.
in the following year,
T0 Year 1 T1 T2

Assume net revenues (revenues minus operating costs) are received at the end of year 1
(T
1
)
Tax assessed at T
1

Tax paid T
2
(assuming tax is paid one year in arrears)
If asset bought at start of year 1
First WDA received at T
1
(date of next tax assessment)

Reduces tax payment at T
2

However if the asset is bought on the last day of the previous year i.e. on the date of a tax
assessment, the first WDA would be received immediately i.e. at T
0
,

which reduces the
tax payment at

T
1

Illustration 1

An asset is bought for $5,000 at the start of an accounting period. It is sold at
the end of the third accounting period for $1,000.
Corporation tax is 30% and paid one year in arrears. Writing down allowances
are available at 25% reducing balance.
What are the tax savings available and when do they arise?

Solution
Tax saving
@ 30%
Timing
$ $ $
Cost
Year 1 WDA 25%
5,000
(1,250)

375

T
2

______

WDV c/f
Year 2 WDA 25%
3,750
(938)

281

T
3

______

WDV c/f
Year 3 Disposal
2,812
(1,000)

Balancing allowance
______

1,812
______

544

T
4

0508
2.3 Other assumptions
Tax rate is constant.
Sufficient taxable profits are available to use all tax deductions in full
Working capital flows have no tax effects e.g. if the level of accounts receivable rises this
does not change the tax situation as tax is charged when revenues are recorded rather
than when the cash is received (see additional notes on working capital in the last
section of this chapter)
2.4 Dealing with taxation
Step 1 Set up table
T0 T
1
T
2
T
3

REVENUE
Step 2 (a) Put in revenues Revenue x x
and operating costs
Operating costs (x) (x)

(b) Total columns for net Net revenue x x
revenues

(c) Calculate tax payable on net Tax @ 30% (x) (x)
revenues

CAPITAL
Step 3 Put in capital outlay and any Investment (x)
disposal value Scrap proceeds x

Step 4 Calculate tax saving on WDAs WDA tax savings x x

(x) x x (x)

Step 5 Total columns for net cash flows
and discount Discount factor r% x x x x

Present value (x) x x x

0509

Example 2

1 A company buys an asset for $10,000 at the beginning of an accounting
period (1 January 19.01) to undertake a two year project.
2 Net cash inflows received at the end of year 1 and year 2 are $5,000.
3 The company sells the asset on the last day of the second year for $6,000.
4 Corporation tax = 33% (paid one year in arrears)
Writing down allowance = 25% reducing balance
5 Cost of capital = 10%
Required:
Calculate the projects NPV.

Solution
T
0
T
1
T
2
T
3

Net cash inflows
Tax @ 33%

Asset
Scrap proceeds
Tax savings on WDAs (W)

Net cash flow
Discount factor
Present value
_______

_______

_______

_______

WORKING

T0 T1 T2 PROFITS
IN
YEAR 1
Asset purchased 1 Jan 19.01
First WDA will be set off
against profits earned in year
1 (T1)
First tax saving at T2
Asset sold 31 Dec 19.02
No WDA in year of sale
Balancing
allowance/charge

0510
$ Tax relief at
33%
Timing
T
0
Investment in asset
Year 1 WDA @ 25%

_______

Year 2 Proceeds

_______

Balancing allowance

Example 3

1 A company buys an asset for $10,000 at the end of the previous accounting
period (31 December 19.00) to undertake a two year project.
2 Net cash inflows received at the end of year 1 and year 2 are $5,000.
3 The asset has zero scrap value when it is disposed of at the end of year 2.
4 CT = 33% (paid one year in arrears)
WDA = 25% reducing balance
5 Cost of capital = 10%
Required:
Calculate the projects NPV.

Solution
T
0
T
1
T
2
T
3

Net cash inflows
Tax @ 33%
Asset
Tax saving on WDA (W)

(10,000)
5,000

5,000
(1,650)

(1,650)

Net cash flow
Discount factor
Present value
_______

_______

_______

_______

NPV =
0511
WORKING
Tax computation

T0 T1 T2 PROFITS
IN
YEAR 0
Asset purchased 31 Dec 19.00
against profits earned in prior
year
First tax relief at T1
Asset scrapped 31 Dec 19.02

$
Tax relief at
33%
Timing
T
0

Year 0
Investment in asset
WDA @ 25%
10,000
(2,500)

825

_______

7,500
Year 1 WDA @ 25%

_______

Year 2 Proceeds

_______

Balancing allowance

3 INFLATION
3.1 Why inflation is a problem for project appraisal
It is hard to estimate, especially when rates are high.
It causes governments to take actions which may impact on business e.g. raising interest
rates, cutting state spending.
Differential inflation rates will occur; different costs and revenues will inflate at
different rates.
It alters the cost of capital (in nominal terms).
It makes historic costs irrelevant and therefore causes ROCE to be overstated.
It creates uncertainty for customers, which may lead to lower demand.
It encourages managers to become short-term in outlook.
0512
3.2 Real and money (or nominal) interest rates
Real rate of interest reflects the rate of interest that would be required in the absence of
inflation.
Money (or nominal) rate of interest reflects the real rate of interest adjusted for the effect
of general inflation (measured by the CPI the Consumer Price Index).

Illustration 2

Suppose you invest $100 today for one year and, in the absence of inflation,
you require a return of 5%. The CPI is expected to rise by 10% over the coming
year.
In one year, in the absence of inflation, you require
$100 1.05 = $105
To maintain the purchasing power of your investment, i.e. to cover inflation
you require
$105 1.1 = $115.50
You therefore require a money return of
100
50 . 15
= 15.5% over the year.

Money rates, real rates and general inflation (CPI) are linked by the Fisher formula:
(1+money rate) = (1+real rate) (1+general inflation rate)

(1+i) = (1+r) (1+h)

i = nominal/money interest rate
r = real interest rate
h = general inflation rate
In the example above
(1 + i) = (1.05) (1.1) = 1.155
i = 15.5%
0513
3.3 General and specific inflation rates
A specific inflation rate is the rate of inflation on an individual item e.g. wage inflation,
materials price inflation.
The general inflation rate is a weighted average of many specific inflation rates, e.g. CPI
3.4 Cash flow forecasts
If there is inflation in the economy there are three ways in which the cash flow forecast for
project appraisal can be performed:
3.4.1 Current cash flows
Cash flows expressed at todays prices i.e. before the effects of inflation.
3.4.2 Money (or nominal) cash flows
Cash flows are inflated to future price levels using the specific inflation rate for each type
of revenue/cost.
This produces a forecast of the physical amount of money that will move in/out of the
company
3.4.3 Real cash flows
Money cash flows with the effect of general inflation removed.
3.5 Discounting
There are three methods of discounting if there is inflation. Each method results in the same
NPV.
3.5.1 Money method
Adjust each cash flow for specific inflation to convert to nominal/money cash flows.
Discount using the nominal/money cost of capital.
3.5.2 Real method
Remove the effects of general inflation from money cash flows to generate real cash
flows.
Discount using the real cost of capital.
3.5.3 Effective method
Express each type of cash flow in current terms i.e. at t
0
prices
Discount at the effective rate for that cash flow
(1+money rate) = (1+effective rate) (1+specific inflation rate)
0514

Illustration 3

One year project
Outlay at T
0
= $5m
Sales for the year are expected to be $10m in current terms, with an expected
specific inflation rate of 5%
Costs for the year are expected to be $3m in current terms, with an expected
specific inflation rate of 3%
CPI expected to rise by 4%
Nominal cost of capital = 6%

Solutions
Money method
T0 T1
Outlay (5)
Sales 10 1.05 = 10.5
Costs (3) 1.03 = (3.09)

___

_____

Money flows (5) 7.41

NPV = (5) +
7.41
1.06
= $1.99m

Real method
T0 T1
Money cash flow (5) 7.41

RPI 4%
7.41
1.04

Real cash flow (5) 7.125

(1 + i) = (1 + r) (1 + h)
(1.06) = (1 + r) (1.04)
r = 1.92307%

NPV = (5) +
0192307 . 1
125 . 7
= $1.99m

0515
Commentary

As money flows are needed to do this, the money method might just as well be
used it gives the same result.
Net cash flow expressed in current terms ($7m) is not the same as real cash flow
($7.125m), because sales and costs are not changing at CPI.

Effective method
Effective discount rates:
for sales:
(1.06) = (1 + e) (1.05)
e = 0.95238%

for costs (1.06) = (1 + e) (1.03)
e = 2.91262%

Technique
Discount cash flows expressed in current terms at effective rates
NPV = (5) +
1.0291262
(3)
1.0095238
10
+ = $1.99m

as before

Effective method can be useful where an annuity is given in todays prices.

Example 4

A project produces a cash inflow at the end of years 13 of $10,000 (at t
0
prices).
Real cost of capital = 10%
CPI = 5%
Inflation of project cash flows = 8%
Required:
Calculate NPV using:
(i) money method
(ii) real method
(iii) effective method.

0516
Solution
(i) Money method
(1 + i) = (1 + r) (1 +h)
=
i =

t $ DF PV
$
1
2
3

______

______
(ii) Real method
t $ DF PV
$
1
2
3
(W)

______

______

WORKING

(iii) Effective method

e =

t $ DF PV
$
13 (W)
______

WORKING

0517

Example 5

1 A company buys a machine today for $10,000
2 Material costs at current prices will be $1,500 pa for three years
Material costs inflate at 8% pa
3 Labour savings at current prices will be $4,000 pa for three years
Labour costs inflate at 5% pa
4 Overhead savings at current prices will be $2,000 pa for three years
Overhead costs inflate at 10% pa
5 Money cost of capital = 15.5%
6 General inflation = 7%
Required:
Calculate the NPV of the project, using:
(i) the money method;
(ii) the effective method;
(iii) the real method.
Ignore taxation.

Solution
(i) Money method
T
0
T
1
T
2
T
3
$ $ $ $
Investment
Materials
Labour savings
Overhead savings
(10,000)

______

_____

_____

_____

Net cash flow
Discount factor

Present value

______

______

_____

_____

_____

_____

_____

_____

NPV =
0518
(ii) Effective method
(a) Calculation of effective rates
Materials
e
=
=

Labour
e
=
=

Overheads
e
=
=

(b) Discount flows at effective rates
Time Cash flow Discount/
annuity
factor
Present
value
0
13
13
13
Investment
Material cost
Labour saving
Overhead saving
(10,000)

1
(W)

(10,000)

Net present value

_____

_____

from tables
(iii) Real method
T
0
T
1
T
2
T
3
Money cash flows (10,000) 4,780 5,080 5,403

Real cash flows
Discount factor
Present value

NPV =

Real rate: (1+i) = (1+r)(1+h)
=
r =
0519

Example 6

A company is considering a project which requires the purchase of a machine
costing $250,000 on 1 January 19.04. Net inflows from the project are expected
to be $80,000 per annum in current terms for the next four years. At the end of
the project it is estimated that the machine will be sold for cash proceeds of
$50,000.
The company has a December year end and pays tax at 33%, 12 months after
the end of the accounting period. The project flows are expected to inflate at
5%, and the companys money cost of capital is 15%. Writing Down
Allowances are given at 25% reducing balance.
Required:
Determine whether the company should proceed with the project.

Solution
WDAs
$ Tax @ 33% Time
y/e 31 December 19.04
Purchase
WDA @ 25%

250,000

______

WDA @ 25%

______

WDA @ 25%

______

Sales proceeds

Balancing allowance
______

______

0520
Project appraisal
T
0
T
1
T
2
T
3
T
4
T
5

Inflows
Tax @ 33%
Initial investment
Scrap
Tax saving on
WDAs

_______

_______

_______

_______

_______

_______

DF

_______

_______

_______

_______

_______

_______

PV

_______

_______

_______

_______

_______

_______

NPV =
Therefore,

4 WORKING CAPITAL
At the start of a project we usually see a cash outflow for the investment in non-current
assets e.g. plant and equipment. However many projects will also require an investment in
net current assets i.e. working capital. For project appraisal working capital is defined as
inventory + accounts receivable accounts payable. Note that this definition excludes cash
the cash flow is found as the change in the level of inventory + accounts receivable
accounts payable.
For example at the start of the project inventory must be purchased, causing a cash outflow.
Over the life of the project the level of accounts receivable may rise, with the result that cash
inflows are less than the sales revenues. On the other hand the level of accounts payable
may also rise, reducing the required investment in working capital and improving the cash
flows because payments to suppliers are below the level of purchases. At the end of the
project the inventory levels may be reduced to zero, all receivables may be collected,
creating a cash inflow.
0521
Movements in working capital need to be incorporated into investment appraisals. Cash
flows are derived as follows:
Increase in net working capital = cash outflow;
Decrease in net working capital = cash inflow.
Unless the question tells you otherwise assume that working capital is released at the
end of a project i.e. the investment in working capital falls to zero, creating a cash
inflow.
Assume that changes in the level of working capital have no tax effects. This is a
realistic assumption because tax will be charged when net revenues accrue rather than
when the cash is received.
Example 7

Sales of a new product are forecast at $100,000 in the first year, increasing by
10% compound per annum. The product has a four year life cycle. Working
capital equal to 15% of annual sales is required at the start of each year. The
companys contribution margin is 40% and no incremental fixed costs are
expected.
Required:
Determine the total cash flow for each year.

Solution
T
0
T
1
T
2
T
3
T
4

$ $ $ $ $

Contribution
Cash re working capital (W)
Total cash flow

(W)
Sales
Level of working capital
Cash re working capital

0522

Key points

The golden rule only discount future, incremental, operating cash flows.
Never discount depreciation it is not a cash flow.
Do not discount finance costs the cost of finance is measured in the
discount rate and is therefore already taken into account.
Exam questions will be in the environment o the UK tax system.
Depreciation expense is not a tax allowable deduction in the UK instead
companies can claim Writing Down Allowances/Capital Allowances.
Discounting with inflation is a difficult area. The key here is consistency
i.e. if inflation is included in the cash flow forecast then make sure you
include it in the discount rate.
Adjusting for changes in working capital is relevant if you are given
accruals-based accounting information which needs to be converted to a
cash flow basis.

FOCUS
You should now be able to:

distinguish relevant from non-relevant costs for investment appraisal;
calculate the effect of Writing Down allowances and corporation tax on project cash
flows;
explain the relationship between inflation and interest rates, distinguishing between
real and nominal rates;
distinguish general inflation from specific price increases and assess their impact on
cash flows;
evaluate capital investment projects on a real terms basis;
evaluate capital investment projects on a nominal terms basis;
evaluate capital investment projects on a current/effective terms basis;
incorporate cash flows relating to changes in the level of working capital.
0523
EXAMPLE SOLUTIONS
Solution 1 Relevant costs
Costs and revenues of proceeding with the project.
$
(1) Costs to date of $150,000 sunk ignore.
(2) Materials purchase price of $60,000 is also sunk.
Opportunity benefit is disposal costs saved.

5,000
(3) Labour cost direct cost of $40,000 will be incurred
regardless of whether or not the project is undertaken
and so is not relevant. Opportunity cost of lost
contribution = 150,000 (100,000 40,000)

(90,000)
Absorption of overheads irrelevant as it is merely an
apportionment of existing costs

(4) Research staff costs
Wages for the year
Redundancy pay increase (35,000 15,000)
(60,000)
(20,000)
(5) Equipment
Deprival value if used in the project = disposal value

Disposal proceeds in one year
(8,000)

6,000
(6) General building services
Apportioned costs irrelevant
Opportunity costs rental forgone

(7,000)

________
(174,000)
Sales value of project 300,000

Increased contribution from project
________

126,000
________

Advice. Proceed with the project.
0524
Solution 2 Tax cash flows
T
0
T
1
T
2
T
3

Net cash inflows
Tax @ 33%
Asset
Scrap proceeds
Tax savings on WDAs (W)

(10,000)
5,000 5,000
(1,650)

6,000
825

(1,650)

495

Net cash flow
10% discount factor
Present Value

NPV = $2, 083
Accept project
_______

(10,000)
1
(10,000)
_______

5,000
0.909
4,545
_______

10,175
0.826
8, 405
_______

(1,155)
0.751
(867)

WORKING
Tax computation

T0 T1 T2 PROFITS
IN
YEAR 1
Asset purchased 1 Jan 19.01
against profits earned in year
1 (T1)
Asset sold 31 Dec 19.02

$ Tax relief at
33%
Timing
T
0
Investment in asset 10,000
Year 1 WDA @ 25% (2,500) 825 T
2

_______

7,500
Year 2 Proceeds (6,000)

_______

Balancing allowance (1,500) 495 T
3

0525
Solution 3 Tax cash flows
T
0
T
1
T
2
T
3

Net cash inflows
Tax @ 33%
Asset
Tax saving on WDA (W)

(10,000)
5,000

825
5,000
(1,650)

619

(1,650)

1,856

Net cash flow
10% discount factor
Present value

NPV = $(1, 272)
Reject project
_______

(10,000)
1
(10,000)
_______

5,825
0.909
5,295
_______

3,969
0.826
3, 278
_______

206
0.751
155

WORKING
Tax computation

T0 T1 T2 PROFITS
IN
YEAR 0
Asset purchased 31 Dec 19.00
against profits earned in prior
year
Asset scrapped 31 Dec 19.02

$
Tax relief at
33%
Timing
T
0

Year 0
Investment in asset
WDA @ 25%
10,000
(2,500)

825

T
1

_______

7,500
Year 1 WDA @ 25% (1,875) 619 T
2

_______

5,625
Year 2 Proceeds

_______

Balancing allowance 5,625 1,856 T
3

0526
Solution 4 Money, real and effective methods
(i) Money method
(1 + i) = (1 + r) (1 + h)
= 1.1 1.05
= 1.155
m = 15.5%
T $ DF (15.5%) PV
$
1
2
3
10,800
11,664
12,597
0.866
0.75
0.649
9,353
8,748
8,175
______
26,276
______
(ii) Real method
T $ DF (10%) PV
$
1
2
3
10,286 (W)
10,580
10,882
0.909
0.826
0.751
9,350
8,739
8,172
______
26,261
______
WORKING
05 . 1
800 , 10

(iii) Effective method
1.155 = (1 + e) 1.08
e = 6.94
T $ DF PV
$
13 10,000 2.627 (W) 26,270
______

WORKING
|
.
|
\
|

3
0694 . 1
1
1
0694 . 0
1
= 2.627
0527
Solution 5 Money, real and effective methods
(i) Money method
T
0
T
1
T
2
T
3
$ $ $ $
Investment
Materials (8%)
Labour savings (5%)
Overhead savings (10%)
(10,000)
(1,620)
4,200
2,200

(1,750)
4,410
2,240

(1,890)
4,631
2,662

______

_____

_____

_____

Net cash flow (10,000) 4,780 5,080 5,403
Discount factor @ 15.5% 1 1
1155 .

1
1155
2
.

1
1155
3
.

Present value

______

(10,000)
______

_____

4,139
_____

_____
3,808
_____

_____

3,507
_____

NPV = $1,454
(ii) Effective method
(a) Calculation of effective rates
Materials (1.155)
e
=
=
(1 + e)(1.08)
6.94%
Labour (1.155)
e
=
=
(1 + e)(1.05)
10%
Overheads (1.155)
e
=
=
(1 + e)(1.05)
5%
(b) Discount flows at effective rates
Time Cash flow Discount/
annuity
factor
Present
value
0
13
13
13
Investment
Material cost
Labour saving
Overhead saving
(10,000)
(1,500)
4,000
2,000
1
2.627(W)
2.487
2.723
(10,000)
(3,941)
9,948
5,446

Net present value

_____

1,453
_____

from tables
WORKING
3 year 6.94% annuity factor = 627 . 2
0694 . 1
1
1
0694 . 0
1
3
=
(

0528
(iii) Real method
T
0
T
1
T
2
T
3
Money cash flows (10,000) 4,780 5,080 5,403
1 1.07 1.07
2
1.07
3
Real cash flows (10,000) 4,467 4,437 4,410
Discount factor @ 7.944% 1 0.926 0.858 0.795
Present value (10,000) 4,136 3,807 3,506

NPV = $1,449
Real rate : (1+i) = (1+r)(1+h)
1.155 = (1+r)(1.07)
r = 7.944%

Solution 6 Tax and inflation
WDAs
Tax @ 33% Time
Purchase
WDA @ 25%

250,000
(62,500)

20,625

T
2

______
187,500

WDA @ 25%

(46,875)

15,469

T
3

______
140,625

WDA @ 25%

(35,156)

11,602

T
4

______
105,469

Sales proceeds

(50,000)

Balancing allowance
______
55,469
______

18,305

T
5

0529
Project appraisal
T
0
T
1
T
2
T
3
T
4
T
5

Inflows 84,000 88,200 92,610 97,241
Tax @ 33% (27,720) (29,106) (30,561) (32,090)
Initial investment (250,000)
Scrap 50,000
WDAs 20,625 15,469 11,602 18,305

_______

_______

_______

_______

_______

_______

(250,000) 84,000 81,105 78,973 128,282 (13,785)
DF @ 15% 1 0.870 0.756 0.658 0.572 0.497

_______

_______

_______

_______

_______

_______

PV (250,000) 73,080 61,315 51,964 73,377 (6,851)

_______

_______

_______

_______

_______

_______

NPV = $2,885
Therefore, accept the project
Solution 7 Working capital
T
0
T
1
T
2
T
3
T
4

$ $ $ $ $
Contribution
Cash re working capital (W)
Total cash flow

(W)
Sales
Level of working capital
Cash re working capital

(15,000)
_______

(15,000)
_______

15,000
(15,000)
_______

40,000
(1,500)
_______

38,500
_______

100,000
16,500
(1,500)
_______

44,000
(1,650)
_______

42,350
_______

110,000
18,150
(1,650)
_______

48.400
(1,815)
_______

46,585
_______

121,000
19,965
(1,815)
_______

53,240
19,965
_______

73,205
_______

133,100
0
19,965
_______

0530

F9FM-Session05 d08jkbn

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SESSION 05 RELEVANT CASH FLOWS FOR DCF

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