chap008.ppt
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This document discusses using discounted cash flow analysis to make investment decisions. It covers topics such as identifying and calculating cash flows, using cash flows rather than accounting profits, using incremental cash flows, treating inflation, and separating investment and financing decisions. An example project for Blooper Industries is presented, showing the capital investment, revenues, expenses, taxes, depreciation, cash flows from operations, and net cash flows over several years to calculate the net present value.
chap008.ppt
- 1. Chapter 8 Fundamentals of Corporate Finance Fifth Edition 際際滷s by Matthew Will McGraw-Hill/Irwin Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved Using Discounted Cash Flow Analysis to Make Investment Decisions
- 2. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 2 Topics Covered Identifying Cash Flows Discounted Cash Flows, Not Profits Incremental Cash Flows Treatment of Inflation Separate Investment & Financing Decisions Calculating Cash Flows Example: Blooper Industries
- 3. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 3 Cash Flow vs. Accounting Income Discount actual cash flows Using accounting income, rather than cash flow, could lead to erroneous decisions. Example A project costs $2,000 and is expected to last 2 years, producing cash income of $1,500 and $500 respectively. The cost of the project can be depreciated at $1,000 per year. Given a 10% required return, compare the NPV using cash flow to the NPV using accounting income.
- 4. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 4 Year 1 Year 2 Cash Income $1500 $ 500 Depreciation -$1000 -$1000 Accounting Income + 500 - 500 32 . 41 $ ) 10 . 1 ( 500 1.10 500 = NPV Apparent 2 Cash Flow vs. Accounting Income
- 5. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 5 Today Year 1 Year 2 Cash Income $1500 $ 500 Project Cost -2000 Free Cash Flow -2000 +1500 + 500 Cash NPV = -2000 1.10 1500 110 500 110 14 2 3 ( . ) ( . ) $223. Cash Flow vs. Accounting Income
- 6. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 6 Incremental Cash Flows Discount incremental cash flows Include All Indirect Effects Forget Sunk Costs Include Opportunity Costs Recognize the Investment in Working Capital Beware of Allocated Overhead Costs Incremental Cash Flow cash flow with project cash flow without project = -
- 7. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 7 Incremental Cash Flows IMPORTANT Ask yourself this question Would the cash flow still exist if the project does not exist? If yes, do not include it in your analysis. If no, include it.
- 8. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 8 Inflation INFLATION RULE Be consistent in how you handle inflation!! Use nominal interest rates to discount nominal cash flows. Use real interest rates to discount real cash flows. You will get the same results, whether you use nominal or real figures
- 9. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 9 Inflation Example You own a lease that will cost you $8,000 next year, increasing at 3% a year (the forecasted inflation rate) for 3 additional years (4 years total). If discount rates are 10% what is the present value cost of the lease? 1 real interest rate = 1+nominal interest rate 1+inflation rate
- 10. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 10 Inflation Example - nominal figures $29,072.98 6,567.86 8,741.82 = 8000x1.03 3 7,014.22 20 . 487 , 8 = 8000x1.03 2 91 . 490 , 7 8,240 = 8000x1.03 1 00 . 000 , 8 8000 0 10% @ PV Flow Cash Year 3 2 10 . 1 82 . 8741 3 10 . 1 20 . 8487 2 10 . 1 8240
- 11. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 11 Inflation Example - real figures 29,072.98 6,567.86 8,000 3 7,014.22 8,000 2 7,490.91 8,000 1 8,000 8,000 0 PV@6.7961% Flow Cash Year 3 2 068 . 1 8,000 068 . 1 8,000 068 . 1 8,000 = $
- 12. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 12 Separation of Investment & Financing Decisions When valuing a project, ignore how the project is financed. Following the logic from incremental analysis ask yourself the following question: Is the project existence dependent on the financing? If no, you must separate financing and investment decisions.
- 13. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 13 Blooper Industries Year 0 1 2 3 4 5 6 Cap Invest WC Change in WC Revenues Expenses Depreciation Pretax Profit .Tax (35%) Profit 10 000 1500 4 075 4 279 4 493 4 717 3 039 0 1500 2 575 204 214 225 1678 3 039 15 000 15 750 16 538 17 364 18 233 10 000 10 500 11025 11576 12 155 2 000 2 000 2 000 2 000 2 000 3 000 3 250 3513 3 788 4 078 1050 1137 1230 1326 1427 1950 2 113 2 , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , 283 2 462 2 651 (,000s)
- 14. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 14 Blooper Industries Cash Flow From Operations (,000s) Revenues - Expenses Depreciation = Profit before tax .-Tax @ 35 % = Net profit + Depreciation = CF from operations 15 000 10 000 2 000 3 000 1 050 1 950 2 000 3 950 , , , , , , , , or $3,950,000
- 15. Copyright 息 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 8- 15 Blooper Industries Net Cash Flow (entire project) (,000s) 4,339 6,329 4,237 4,069 3,909 1,375 11,500 - Flow Cash Net 4,651 4,462 4,283 4,113 3,950 Op from CF 039 , 3 1,678 225 - 214 - 204 - 2,575 - 1,500 - in WC Change 300 , 1 10,000 - value Salvage Invest Cap 6 5 4 3 2 1 0 Year NPV @ 12% = $4,222,350