FIN 311 solution

FIN 311 chapter 9 solution
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  Chapter 9 – Making Capital Investment Decisions Introduction The cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is acceptedThese cash flows are called incremental cash flowsThe stand-alone principle allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flowsCash flow estimation is the most important step in the capital budgeting. It is also the most difficult. In large firms, many departments are involved:ar!eting ngineering#perations$ccounting%ersonnel&ecause of its difficulty, forecast errors can be large thus ma!ing poor projects can appear to be good and good project appear poor. It does not matter what type of analytical techni'ue is used, if the cash flows contain large errors, poor decisions can be made.The role of financial staffs in the forecasting processCoordinating the efforts of the other departments nsuring all participants use a consistent set of economic assumptions$ssure there are no biases inherent in the forecastToo estimate cash flows( we must identify the relevant cash flows. )e want to use cash flows not accounting income.The incremental cash flows, for project evaluation, consist of any and all changes in a firm*s future cash flows that are a direct conse'uence of ta!ing the project.+un! Costs#pportunity CostsTurning a building we own into a condo comple. The opportunity costs would be the mar!et value of the building. in // Chapter 0 1ecture 2otes%age /  ternalities or +ide effects rosion:#pening a new branch for a ban!.+ynergy+hipping and Installation CostsChanges in 2et )or!ing Capital 2ormally, a new project will re'uire some investment in new inventory and accounts li!e that. This increases net wor!ing capital and should be considered in the analysis.inancing Costs 2ot considered in cash flows.#ther Issues)hen the flows actually occur $fter-ta cash flows %age 3in // Chapter 0 1ecture 2otes  $ company is considering a new project that will last for five years. The e'uipment necessary for production will cost 4566,666 and will be depreciated on a straight-line basis to a zero salvage value. The project will generate sales of 466,666 per year. 7ariable costs are 56  percent of sales and fied costs are 46,666. The project will re'uire an initial investment of 486,666 in net wor!ing capital. The ta rate is 6 percent and the re'uired return is /3 percent. )hat is the paybac! period, 2%7, and I99 Initial Investment 'uip:-566,666; 2)C-86,666 2et Investment <C 6 =-4586,666 OCF +ales466,6669emember:7C/36,666#C > &IT ? @ep - TaesC6,666#C > A6,666 ? B6,666  3/,666@epB6,666#C > /30,666 &T4A6,666$nother way:Ta3/,666#C > 2I ? @ep 2I450,666#C > 50,666 ? B6,666#C > /30,666 Non-OCF or Terminal Year CF $fter-Ta +alvage 7alue69eturn of 2)C86,666 2on-#C86,666 NPVI!! Calc lation C 6 -586,666C / /30,666 / 5C 3 /30,666 ? 86,666 > /A0,666 3 /I/3DC%T2%745,BA.5AC%TI99/8.E8D%aybac!.50 years in // Chapter 0 1ecture 2otes%age   Fere is another way to approach this problem. It is called the Ta +hield approach and is used tocalculate the #C.#C > G+ales  CostsH</  T C = ? @epreciation<T C =#C > G<%=  <7C=  CH</  T C = ? @epreciation<T C = Initial Investment 'uip:-566,666; 2)C-86,666 2et Investment <C 6 =-4586,666 OCF #C > G+ales - CostsH</  T C = ? @epreciation<T C =#C /  8  > <66,666  <6.56=<66,666=  6,666=</  6.6= ? <B6,666=<6.6=#C /  8  > /30,666 Non-OCF or Terminal Year CF $fter-Ta +alvage 7alue69eturn of 2)C86,666 2on-#C86,666 NPVI!! Calc lation C 6 -586,666C / /30,666 / 5C 3 /30,666 ? 86,666 > /A0,666 3 /I/3DC%T2%745,BA.5AC%TI99/8.E8D%aybac!.50 years %age 5in // Chapter 0 1ecture 2otes
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