1. Learning Objectives (a) Develop proforma Project Income Statement Using Excel Spreadsheet (b) Compute Net Project Cash flows, NPV, IRR and PayBack Period $ 200,000 4% $ (120,000) 1) Life Period of the Equipment = 4 years 2) New equipment cost 3) Equipment ship & install cost 4) Related start up cost 5) Inventory increase 6) Accounts Payable increase 7) Equip. Salvage Value Estimated End of Year 4 (fully depreciated) 8) Sales for first year (1) (200,000) 9) Sales increase per year (25,000) 10) Operating cost: (5,000) (60 Percent of Sales) 25,000 11) Depreciation (Straight Line)/YR 5,000 12) Tax rate 15,000 13) Cost of Capital (WACC) -60% $ 160,000) 35% 10% ESTIMATING Initial Outlay (Cash Flow, CFO, T=0) YEAR CFO CF2 CF3 CF4 CF1 1 Investments: 1) Equipment cost 2) Shipping and Install cost 3) Start up expenses Total Basis Cost (1+2+3) 4) Net Working Capital Inventory Inc.- Acct. Payable Inc. (20,000) $ $ - $ Total Initial Outlay Operations: Revenue Operating Cost Depreciation EBIT Taxes Net Income (LOSS) TAX SHIELD DUE TO LOSS Add back Depreciation XXXXX Total Operating Cash Flow XXXXX XXXXX XXXXX XXXXX PU $ - $ - $ - $ 20,000 47 Terminal (END of 4th YEAR) 48 1) Release of Working Capital 49 2) Salvage value (after tax) 50 Total 52 Project Net Cash Flows $ - $ - $ - $ - $ 881 (a) 54 (b) 54 NPV = IRR = Payback= 55 COST of CAPITAL (WACC) or DISCOUNT RATE OF THE PROJECT = 10% 56 Q#1 Would you accept the project based on NPV, IRR? Would you accept the project based on Payback rule if project cut-off period is 3 years? 59 Q#2 SENSITIVITY and SCENARIO ANALYIS. Capital Budgeting (Investment ) Decisions Estimate NPV, IRR and Payback Period of the project if Marginal Corporate Tax is reduced to 20%. Would you accept or reject the project? Assume Straight-Line Depreciation. Estimate NPV, IRR and Payback period of the project if Equipment is fully depreciated in first year and tax rate is reduced to 20%. Would you accept or reject the project? 57 (c) As a CFO of the firm, which of the above two scenario (a) or (b) would you choose? Why? 889 Q#3 How would you explain to your CEO what NPV means? 70 Q#4 What are advantages and disadvantages of using only Payback method? 71 Q#5 What are advantages and disadvantages of using NPV versus IRR? 72 Q#6 Explain the difference between independent projects and mutually exclusive projects. When you are confronted with Mutually Exclusive Projects and have coflicts with NPV and IRR results, which criterion would you use (NPV or IRR) and why