CashFlow

[(SOCDI)*(1t)]+D
[($100,000$45,000$15,000$10,000)*
(1.3)]+$15,000=$36,000.

CBCF = ((S - OC - D) * (1-t)) + D - NWC FA + (E * (1-t))

A4yearprojectrequires$1,000,000ofnewequipmentwhichwillbedepreciated
accordingto

Sales(S)$100,000.
CashOperatingCosts(OC)45,000.
MACRSovera3yearlife.Theprojectreplacesa4yearoldassetwith
Depreciation(D)15,000.
anoriginalcostof$600,000andaMACRSlifeof5years.Thetaxrate
EarningsBeforeInterestandTax(EBIT)40,000.
is30%.Annualsaleswillriseby$300,000andannualcash
Interest(I)10,000.
operatingcostswillriseby$100,000.Theassetbeingreplacedcanbe
NetProfitBeforeTax(NPBT)30,000.
sold for $120,000 and there is a $50,000 increase in net working
capital.
Tax(30%)9,000.
ICO = $935,400 = $1,000,000 [120,000 (120,000 (600,000 x
NetProfitAfterTax=NetIncome(NPAT)21,000.
(.11+.06)))x.3]+50,000
Dividend7,000.
CBCF1 = $219,200 = ((300,000 100,000)x (1-.3)) + [((1,000,000
AdditiontoRetainedEarnings$14,000.
x .33)-(600,000x.11))x.3]
Numberofshares10,000.
CBCF2 = $264,200 = ((300,000 100,000)x (1-.3)) + [((1,000,000 x
EarningsperShare(EPS)=$21,000/10,000$2.10
.45)-(600,000x.06))x.3]
DividendsperShare(DPS)=$7,000/10,000$.70
CBCF3 = $185,000 = ((300,000 100,000)x (1-.3)) + [1,000,000 x .
15x.3]
DividendPayoutRatio(DPR)=$.70/$2.1033%
orDividends/NetIncome=$7,000/$21,000
CashFlow=NPAT+Depreciation=$21,000+$15,000=$36
GOAL OF THE CORPORATION
Familiarity with accounting statements
Economic Value Added (EVA) and
Market Value Added (MVA)
A different company has an Actual
Cash Flow = $9,000, Depreciation =
$4,000, paid $8,000 of interest, repaid $3,000 of debt, and pays 30% in
tax. Capital Budgeting Cash Flow =
CBCF = ACF + Int x (1-t) +
repayment of debt = $9,000 +
($8,000 x (1-.3)) + $3,000 = $17,600

Cost $100. PMT = $10. n = 18 $100./$10. = 10 =

(PVIFA(IRR,18) IRR = 7%
Cost $100. PMT = $25. n = 9 $100./$25. = 4 = (PVIFA(IRR,9)
IRR = 20%
5. An increase in Net Working Capital will always A increase
the Initial Cash Outlay
6. Keeping an asset you other wise would have sold will always
A increase the Initial Cash Outlay
7. Selling a replaced asset for more than book value will always
B decrease (since you are selling something) the Initial Cash
Outlay by E less (since you will pay tax on the gain (mkt >
book)) than the market value of the asset you sell.

4. For a profitable company, an increase in depreciation A increases because it is a noncash expense and saves taxes cash flow.
5. The cash flow from depreciation can be described as C = Cost x Depr % x tax rate
6. You own an asset that originally cost $100,000 and will depreciate it by 12% this year.
You pay 30% tax.
The cash flow from depreciation is $3,600 = $100,000 x .12 x .3
7. As the growth rate increases, the value of a growing perpetuity
increases as the denominator becomes smaller
10. For a company that pays interest and repays debt, Capital
Budgeting Cash Flow is always larger than Actual Cash Flow because
ACF is reduced by interest and debt repayment but CBCF is not.
4. A project has most of its cash inflows early in its life. You approximate
the IRR using the average cash flow approach. The actual IRR will be A
A. higher
B. lower
5. Two projects have the same initial cash outlay, life, and total cash
inflows over their life. Project A receives most of its cash inflows late in
its life while B receives most of its cash inflows early in its life. Which
project will have the: HIGHER IRR? B
6.If you hold project life constant, a shorter Payback Period yields a A
IRR. A. higher B. lower
7. A 10-year project with an annuity of benefits and a Payback Period =
5 has a 15% IRR.
PVIFA (15%,10) = 5 = Payback Period
8. A project that lasts forever with an annuity of benefits and a Payback
Period =5 has a 20% IRR.

7. Sales decrease from $300,000 to $290,000 while cash

operating costs decrease from $100,000 to $80,000.
Depreciation increases by $15,000. The tax rate is 30%
Incremental Capital Budgeting Cash Flow = $11,500
Adjusted Income Statement:
[(($290,000 - $30,000) - ($80,000 - $100,000) - $15,000) x
(1-.3)] + $15,000
[(-$10,000 - - $20,000 - $15,000) x .7] + $15,000
[-$5,000 x .7] + $15,000
Need to immediately capture tax
savings on loss to achieve cash flow
Cash Non-cash:
[(-$10,000 - - $20,000] x (1-.3)] + ($15,000 x .3) = [$10,000
x .7] + $4,500 Fail to see problem with loss
A company uses 40% debt financing at a cost
of 10%, equity financing costs 14%.
The tax rate is 30%.
WACC = (.4 * .10 * (1-.3)) + ((1 - .4) * .14) =
11.2%
1. A project has inflows that exceed outflows and IRRs of 10%
and 54%.
If the required rate of return is 8% this is a GOOD
project and at 16% this is a BAD project.
IN > OUT so starts positive, becomes negative at 10%
2.A project has outflows that exceed inflows and IRRs of 10%
and 78%.
If the required rate of return is 18% this is a GOOD
project and at 6% this is a BAD project.
OUT > IN so starts negative, becomes positive at 10%
3. A project can only have multiple IRRs if C.there are multiple
sign changes

7.

Project
A
B
Delta
ICO
$2,106
$2,901
$795
CBCF1
$1,000
$1,292
$292
CBCF2
$1,000
$1,292
$292
CBCF3
$1,000
$1,292
$292
IRR
20%
16%
5%
2106/1000 = 2.106
2901 / 1292 = 2.2454
795/292 = 2.7226
If the required rate of return = 8% and A and B are mutually
exclusive, invest in A 8 > 5
If the required rate of return = 4% and A and B are mutually
exclusive, invest in B 4 < 5
8.

Project
C
D
Delta
ICO
$1,260
$2,887
1627
CBCF1
$600
$1,100
$500
CBCF2
$500
$1,100
$600
CBCF3
$400
$1,100
$700
IRR
10%
7%
5%
1260/500 = 2.52 implies 9% try higher 2887/1100 = 2.6245
implies 7%
1627/600 = 2.7117 implies 5% try lower but
still 5% to nearest whole percent
If the required rate of return = 2% and C and D are mutually
exclusive, invest in D 5> 2
If the required rate of return = 6% and C and D are mutually
exclusive, invest in C 5 < 6
9. The IRR of Delta is 10% and the required rate of return is
14% Accept the B smaller project if they are mutually
exclusive.