Capital Budgeting Cash Flows

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Capital Budgeting Cash Flows

• Prepared by Keldon Bauer
• FIL 240

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Capital Budgeting Decision

• Capital Budgeting
• The process of evaluating and selecting long-term
  investments.
• Capital Expenditure
• An outlay expected to benefit the firm over at
  least 1 year.
• Operating expenditures benefit the firm over a
  period less than 1 year.

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Capital Budgeting Decision

• Steps in the Process
• Proposal generation.
• Review and analysis.
• Decision making.
• Implementation.
• Follow-up.

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Basic Terminology

• Independent versus Mutually Exclusive.
• Unlimited Funds versus Capital Rationing.
• Accept-Reject versus Ranking .
• Conventional versus Non-Conventional Cash Flow
  Patterns.

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Relevant Cash Flows

• Incremental Cash Flows
• Marginal cash flow associated with adopting the
  proposed project.
• Major Cash Flow Components
• Initial Cash Flow
• Operating Cash Flow
• Terminal Cash Flow

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Relevant Cash Flows

• Expansion versus Replacement Decisions.
• Sunk Costs and Opportunity Costs.
• Sunk costs are ignored (incremental costs are
  zero).
• Opportunity costs are includes, since they
  represent costs (or revenues) forgone.

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1. Initial Cash Flow

• Cost of New Asset
• Include shipping and installation.
• After-tax Proceeds from Sale of Old Asset
• Removal/Sale
• Cleanup costs
• Net of tax effect
• Book value, tax profit (recaptured depreciation.

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1. Initial Cash Flow

• Change in Net Working Capital.
• Summary
• Installed cost of new assets
• After-tax proceeds from sale of old assets.
• Change in net working capital
• Initial Cash Flow

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2. Operating Cash Flows

• After-tax Incremental Cash Flows from Operations.
• Be careful specific under replacement decisions.
• Usually compared to not replacing now.
• After-tax usually is earnings less the
  depreciation shielded tax.
• Generally assume accelerated depreciation.
• See page 94 for MACRS table.

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2. Operating Cash Flows

• Summary
• Operating Cash Flow NOPAT Deprec.
• See page 100.
• If relevant, find the incremental cash flow, by
  finding the difference between the OCF for the
  proposed project and the OCF of the best
  alternative (what you are currently doing).

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3. Terminal Cash Flow

• Proceeds from Sale of Assets
• Net of sale, removal and cleanup.
• Taxes on Sale of Assets
• Book value and profit.
• Change in Net Working Capital
• Typically, setting net working capital back the
  way it was.

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Summarizing Relevant CFs

• Use a cash flow timeline.
• Rather than using the format presented in the
  text, bring net inflows and outflows down
• Make outflows negative,
• Make inflows positive.