CH 12: Cash Flow Estimation and Risk Analysis

NCF=

EBIT (1-T) + D

Why is interest expense ignored when determining operating cash flows?

Can’t take out the dollar amount when we take it out in percentages

How does an increase in depreciation affect NI and NCF?

NI decreases and NCF increases

The change in the firms total cash flow that occurs as a direct result of accepting the project

Incremental Cash Flows

an outlay not affected by the decision under consideration

Sunk costs

cash flow given up by taking on the project

opportunity cost

effects of a project on others parts of the firm (i.e. cannibalization of sales from an existing product)

externalities

What are the three types of externalities?

Negative within firm
Positive within firm
Environment

What are the assets under the 3 year MACRS class?

certain special manufacturing tools

What are the assets under the 5 year MACRS class?

automobiles
light duty trucks
computers
certain special manufacturing equipment

What are the assets under the 7 year MACRS class?

most industrial equipment
office furniture
fixtures

What type of assets are not depreciated?

LAND

Depreciable Basis=

Price + Shipping + Modifications + Installation

used for tax purposes; makes it more appropriate for capital budgeting decisions than straight line since taxing affects cash flow; does NOT subtract salvage value to determine depreciable basis

MACRS

Depreciation per year (for SL depreciation)=

(cost - SV) / life

What are the 3 types of cash flows

Initial investment outlay
Operating Cash Flows
Terminal cash flows

What are the labels for the replacement project at T=0?

(Buy New)
+ Sell Old
(Tax Effect)
+/- Change in NWC
= IIO

What are the labels for the replacement project at the t=n?

OCF
Sell New
(Tax Effect)
(Missed Sale Old)
Missed Tax Effect
± change in NWC
= CFn

Tax Effect =

(MV - BV) (T)

OCF =

(change in Rev - Costs) (1-T) + T(Dnew -Dold)

If a project’s forecasted cash flows do NOT have expected inflation build into them, then should the cost of capital (k) include an inflation premium?

NO

What could have been a sunk cost for the replacement project?

Research

What is the opportunity cost for the replacement project?

lost sale of old machine

Why is interest expense not subtracted in the OCF formula?

We took Kd and Ke by dividing (1+k)^n

What is assumed when you directly compare NPVs of projects with different lives?

Breaking Even

measures the % change in NPV that results from a given % change in input (other variables held at expected values)

sensitivity analysis

What are the techniques to assess stand alone risk?

Sensitivity Analysis
Scenario Analysis
Monte Carlo Simulator

compare good and bad sets of financial circumstances are compared to a most likely/base case situation

Scenario Analysis

According to scenario analysis, the greater the CV

the more risky the scenario is

probable feature events are stimulated on company generating estimated rates of return and risk indexes

monte carlo simulation

runs many scenarios to determine expected NPV and standard dev

monte carlo simulation