B D E F H 10 1. Learning Objectives 11(a) Develop proforma Project Income Statement Using Excel Spreadsheet 12 (b) Compute Net Project Cash flows, NPV, IRR and PayBack Period 3 (c) Develop Problem-Solving and Critical Thinking Skills 4 15 61) Life Period of the Equipment = 4 years 172) New equipment cost 183) Equipment ship & install cost 94) Related start up cost 05) Inventory increase 16) Accounts Payable increase 2 7) Equip. Salvage Value Estimated 3 End of Year 4 (fully depreciated) 24 25 6 ESTIMATING Initial Outlay (Cash Flow, CFO, T= 0) 8) Sales for first year (1) $ 200,000 $ (200,000) 9) Sales increase per year $ (35,000) 10) Operating cost: (5,000) (60 Percent of Sales 25,000 11) Depreciation (Straight Line)/YR $ 5,000 12) Tax rate 5% $ (120,000) -60% (60,000) 35% 10% 15,000 13) Cost of Capital (WACC) 7 8 YEAR 9 Investments: 11) Equipment cost 22) Shipping and Install cost 33) Start up expenses 4 Total Basis Cost (1+2+3) 54) Net Working Capital 6 Inventory Inc.- Acct. Payable Inc. 7 38 Total Initial Outlay 99 CF0 0 CF1 1 CF2 CF3 CF4 3 4 $ (20,000) $ 36 Inventory Inc.- Acct. Payable Inc. (20,000) $ 37 38 Total Initial Outlay 39 32 2) Shipping and Install cost 33 3) Start up expenses 34 Total Basis Cost (1+2+3) 35 4) Net Working Capital $ 69 S - S 44 EBIT 45 Taxes 46 Net Income (LOSS) XXXXXX XXXXX XXXXX XXXXX 47 TAX SHIELD DUE TO LOSS 48 Add back Depreciation 49 50 Total Operating Cash Flow XXXXX XXXXX XXXXX XXXXX 51 40 Operations: 41 Revenue 42 Operating Cost 43 Depreciation 52 Terminal (END of 4th YEAR) 53 1) Release of Working Capital 54 2) Salvage value (after tax) 55 56 57 58 Total Project Net Cash Flows 59 NPV= $ $ 20,000 XXXXXX $ $ IRR= Payback= Sheet1 Sheet2 Sheet3 + Ready 54 2) Salvage value (after tax) 55 Total 56 57 Project Net Cash Flows 58 59 NPV= F H XXXXXX $ $ Payback= IRR= 60 COST of CAPITAL (WACC) or DISCOUNT RATE OF THE PROJECT=10% 61 Q#1 62 63 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? 64 Q#2 SENSITIVITY and SCENARIO ANALYIS. 65 66 (a) 67 68 69 (b) 70 71 72 (c) 73 74 Q#3 75 Q#4 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? As a CFO of the firm, which of the above two scenario (a) or (b) would you choose? Why? How would you explain to your CEO what NPV means? What are advantages and disadvantages of using only Payback method? 76 Q#5 What are advantages and disadvantages of using NPV versus IRR? 77 Q#6 Explain the difference between independent projects and mutually exclusive projects. 78 79 80 81 82 83 84 85 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