Chapter Summary 10!
Joe Roselli!
“Remember that the NPV is the optimal capital budgeting tool however there are
estimates throughout that need to be considered which include the Cash Flows (CF),
Net investment (NINV), and the required return (k). The first part of the process is
identifying relevant cash flows, creating pro-forma statements, and thenturning this
accounting info into financial info. Now the relevant cash flows are cash flows that
should be included in a capital budgeting analysis and are those that will only occur or
not occurs if the project is accepted. These cash flows are called incremental cash
flows. The stand-alone principle allows us to analyze each project in isolation from the
firm simply by focusing on incremental cash flows. A few common types of cash flows
include sunk costs, opportunity costs, changes in net working capital (NWC), financing
costs, and taxes. Some of the side effects include benefits to other projects but could
also include costs to other projects. !
“The depreciation expense used for capital budgeting should be the depreciation
schedule required by the IRS for tax purposes. Now depreciation itself is a non-cash
expense and is only relevant because it affects taxes. When computing depreciation
we have straight line which is the initial cost minus the salvage divided by the useful life
of the product. Now if the salvage value is different from the book value of the asset,
then there is a tax effect. MACRS or Modified Accelerated Cost Recovery System is a
depreciation system where you need to first place assets into classes defined by years
of useful life and then assets are devalued by a set percentage until zero salvage.!
“Now, moving on to the project cash flow from assets we need to understand
that the POCF=PEBIT+PDEPR-PTAXES. Inflows from the project on a per-period basis
are derived from the pro-forma statements and are hopefully positive for at least more
periods. The PNCS=project spending on fixed assets and is usually a time zero outflow
ONLY unless there is some salvage value of concern. Now the
PChangeNWC=Changes in operating liquidity required by the project and is usually