FIN 305 Lecture Notes - Lecture 50: Operating Cash Flow, Cash Flow, Sunk Costs

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skykangaroo617

28 Apr 2019

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Cash flows that will occur if a capital budgeting project is accepted, but that will not occur if the investment is rejected. Costs that have already occurred or will occur in the future, regardless of whether a project is accepted or rejected. ***if your decision does not affect a cash flow, then the cash flow shouldn"t affect your decision. For an investment are its incremental, after-tax, cash flows, which ignore financing costs and reflect adjustments for any noncash charges, typically depreciation. Includes purchase price of asset, installation and delivery costs, and any investment for needed additions to net working capital tied to the project. Includes revenues and expenses, taxes (including cfs due to tax deductible depreciation expense), opportunity costs and externalities. Include after tax salvage value and reduction in net working capital . Change in operating expenses 2,500/year: ,000, ,000, ,000, ,500. The estimated resale value of an asset at the end of its useful life.

Related Questions

Gammy is considering building a facility to manufacture cupcakes to distribute nationally. Your assignment involves both the calculation of cash flows associated with the new investment under consideration and the evaluation of several mutually exclusive projects. Grammy wants you to meet with everyone involved and write a meeting report for the board of directors that includes your recommendation. In addition to the recommendation, you have been asked to respond to a number of questions aimed at understanding the capital-budgeting process. Grammy wants to be sure that she and the board of directors understand cash flow and capital budgeting.

We are considering constructing a building to manufacture cupcakes. Currently we are in the 34 percent marginal tax bracket with a 15 percent required rate of return or cost of capital. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. The following information describes the project:

Cost of new plant and equipment	$7,900,000
Shipping and installation costs	$ 100,000
Unit Sales	Year Units Sold 1 70,000 2 120,000 3 140,000 4 80,000 5 60,000
Sales price per unit	$300/unit in years 1 through 4, $260/unit in year 5
Variable cost per unit	$180/unit
Annual fixed costs	$200,000 per year in years 1 â 5
Working-capital requirements	There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
The depreciation method	Use the simplified straight-line method over 5 years. Assume the plant and equipment will have no salvage value after 5 years.

5. Answer the following questions:

a. Should you focus on cash flows or accounting profits in making the capital-budgeting decision? Should you be interested in incremental cash flows, incremental profits, total free cash flow, or total profits?

b. How does depreciation affect free cash flow?

c. How do sunk costs affect the determination of cash flows?

d. What is the projectâs initial outlay?

e. What are the differential cash flows over the projectâs life?

f. What is the terminal cash flow?

g. Draw a cash-flow diagram for this project.

h. What is its net present value?

i. What is its internal rate of return?

j. Should the project be accepted? Why or why not?

k. How does Genesis 47: 18 â 19 relate to this project and cash flow management?

Given a project's expected cash flows, it is easy to calculate its NPV, IRR, MIRR, payback, and discounted payback. Cash flows are estimated based on information from various sources. There is uncertainty in a project's forecasted cash flows, and some projects are more uncertain and thus riskier than others. In this chapter, we illustrate how project cash flows are estimated, discuss techniques for measuring risk, and discuss how to choose between projects that have significantly different lives, are mutually exclusive, and can be repeated.

The most critical step in capital budgeting analysis is cash flow estimation.

The key is to focus on only

a. relevant

b. net income

c. incremental accounting income or

d. incremental cash flows.

Factors that complicate the analysis are sunk costs, opportunity costs, externalities, changes in net operating working capital, and salvage values. Adjustments to the analysis must be made for

a. inflation

b. interest

c. dividends

We concentrate on expansion project analyses here but there are similarities when analyzing replacement projects.

Give the correct response to each of the following questions.

Which of the following items should be included in the capital budgeting analysis?
a. Sunk costs

b. Interest payments

c. Dividend payments

d. Opportunity costs

An outlay that was incurred in the past and cannot be recovered in the future regardless of whether the project under consideration is accepted is known as
a. Opportunity cost

b. Externality

c. Sunk cost

d. Cannibalization

Which of the following is an example of an opportunity cost?
a. A publisher introduces a new textbook which reduces sales of one of their existing textbooks.
b. A firm has land that can be used in building a new store. If the new store is not built, the firm could sell the land for $2 million (net of taxes).
c. Apple's investment in the iTunes music store boosted sales of its iPod.
d. The cost of a report done 2 years ago to investigate the potential of a new plant and the permits required to build it.
e. Statements a and d are both examples of opportunity costs.
The correct response is -Select-statement astatement bstatement cstatement dstatement eItem 6 .

Which of the following is an example of cannibalization?
a. A publisher introduces a new textbook which reduces sales of one of their existing textbooks.
b. A firm has land that can be used in building a new store. If the new store is not built, the firm could sell the land for $2 million (net of taxes).
c. Apple's investment in the iTunes music store boosted sales of its iPod.
d. The cost of a report done 2 years ago to investigate the potential of a new plant and the permits required to build it.
e. Statements c and d are both examples of cannibalization.
The correct response is -Select-statement astatement bstatement cstatement dstatement eItem 7 .

A manufacturing company is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 45% of sales. Indirect incremental costs are estimated at $95,000 a year. The project requires a new plant that will cost a total of $1,500,000, which will be a depreciated straight line over the next 5 years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000. Assume there is no need for additional investment in building the land for the project. The firm's marginal tax rate is 35%, and its cost of capital is 10%. To receive full credit on this assignment, please show all work, including formulae and calculations used to arrive at financial values. Assignment Guidelines: Using the information in the assignment description: Prepare a statement showing the incremental cash flows for this project over an 8-year period. Calculate the payback period (P/B) and the net present value (NPV) for the project. Answer the following questions based on your P/B and NPV calculations: Do you think the project should be accepted? Why? Assume the company has a P/B (payback) policy of not accepting projects with life of over 3 years. If the project required additional investment in land and building, how would this affect your decision? Explain. Your submitted assignment (125 points) must include the following: A double-spaced Word document of 2

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FIN 305 Lecture Notes - Lecture 50: Operating Cash Flow, Cash Flow, Sunk Costs

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