Ross7eCh07Net-Present-Value-and-Capital-Budgeting(公司理財(cái)-羅斯-第七版)課件

CHAPTER7NetPresentValue

andCapitalBudgeting0CHAPTER7NetPresentValue

andChapterOutline7.1IncrementalCashFlows7.2TheBaldwinCompany:AnExample7.3TheBoeing777:AReal-WorldExample7.4InflationandCapitalBudgeting7.5InvestmentsofUnequalLives:TheEquivalentAnnualCostMethod7.6SummaryandConclusions1ChapterOutline7.1Incremental7.1IncrementalCashFlowsCashflowsmatter—notaccountingearnings.Sunkcostsdon’tmatter.Incrementalcashflowsmatter.Opportunitycostsmatter.Sideeffectslikesynergyanderosionmatter.Taxesmatter:wewantincrementalafter-taxcashflows.Inflationmatters.27.1IncrementalCashFlowsCashCashFlows—NotAccountingEarningsConsiderdepreciationexpense.Youneverwriteacheckmadeoutto“depreciation”.Muchoftheworkinevaluatingaprojectliesintakingaccountingnumbersandgeneratingcashflows.3CashFlows—NotAccountingEarnIncrementalCashFlowsSunkcostsOpportunitycostsdomatter.JustbecauseaprojecthasapositiveNPVthatdoesnotmeanthatitshouldalsohaveautomaticacceptance.SpecificallyifanotherprojectwithahigherNPVwouldhavetobepassedupweshouldnotproceed.4IncrementalCashFlowsSunkcosIncrementalCashFlowsSideeffectsmatter.Erosion(Ifournewproductcausesexistingcustomerstodemandlessofcurrentproducts,weneedtorecognizethat.)Synergy5IncrementalCashFlowsSideeffEstimatingCashFlowsCashFlowsfromOperationsRecallthat:OperatingCashFlow=EBIT–Taxes+DepreciationNetCapitalSpendingDon’tforgetsalvagevalue(aftertax,ofcourse).6EstimatingCashFlowsCashFlowInterestExpenseLaterchapterswilldealwiththeimpactthattheamountofdebtthatafirmhasinitscapitalstructurehasonfirmvalue.Fornow,it’senoughtoassumethatthefirm’slevelofdebt(henceinterestexpense)isindependentoftheprojectathand.7InterestExpenseLaterchapters7.2TheBaldwinCompany:AnExample

Costsoftestmarketing(alreadyspent):$250,000. Currentmarketvalueofproposedfactorysite(whichweown):$150,000. Costofbowlingballmachine:$100,000(depreciatedaccordingtoACRS5-yearlife). Increaseinnetworkingcapital:$10,000. Production(inunits)byyearduring5-yearlifeofthemachine:5,000,8,000,12,000,10,000,6,000. Priceduringfirstyearis$20;priceincreases2%peryearthereafter. Productioncostsduringfirstyearare$10perunitandincrease10%peryearthereafter. Annualinflationrate:5% WorkingCapital:initially$10,000changeswithsales.87.2TheBaldwinCompany:AnExTheWorksheetforCashFlows

oftheBaldwinCompany

Year0 Year1 Year2 Year3 Year4Year5Investments:(1) Bowlingballmachine –100.00 21.76*(2) Accumulated 20.00 52.00 71.20 82.7294.24depreciation(3) Adjustedbasisof 80.00 48.00 28.80 17.285.76machineafter

depreciation(endofyear)(4) Opportunitycost –150.00 150.00

(warehouse)(5) Networkingcapital 10.00 10.00 16.32 24.97 21.22 0(endofyear)(6) Changeinnet –10.00 –6.32 –8.65 3.7521.22workingcapital(7) Totalcashflowof –260.00 –6.32 –8.65 3.75192.98investment

[(1)+(4)+(6)]*Weassumethattheendingmarketvalueofthecapitalinvestmentatyear5is$30,000.Capitalgainisthedifferencebetweenendingmarketvalueandadjustedbasisofthemachine.Theadjustedbasisistheoriginalpurchasepriceofthemachinelessdepreciation.Thecapitalgainis$24,240(=$30,000–$5,760).WewillassumetheincrementalcorporatetaxforBaldwinonthisprojectis34percent.Capitalgainsarenowtaxedattheordinaryincomerate,sothecapitalgainstaxdueis$8,240[0.34($30,000–$5,760)].Theafter-taxsalvagevalueis$30,000–[0.34($30,000–$5,760)]=21,760.($thousands)(Allcashflowsoccurattheendoftheyear.)9TheWorksheetforCashFlows

oTheWorksheetforCashFlowsoftheBaldwinCompany($thousands)(Allcashflowsoccurattheendoftheyear.)

Year0 Year1 Year2 Year3 Year4Year5Investments:(1) Bowlingballmachine –100.00 21.76*(2) Accumulated 20.00 52.00 71.20 82.7294.24depreciation(3) Adjustedbasisof 80.00 48.00 28.80 17.285.76machineafter

depreciation(endofyear)(4) Opportunitycost –150.00 150.00

(warehouse)(5) Networkingcapital 10.00 10.00 16.32 24.97 21.22 0(endofyear)(6) Changeinnet –10.00 –6.32 –8.65 3.7521.22workingcapital(7) Totalcashflowof –260.00 –6.32 –8.65 3.75192.98investment

[(1)+(4)+(6)]150Attheendoftheproject,thewarehouseisunencumbered,sowecansellitifwewantto.10TheWorksheetforCashFlowsoTheWorksheetforCashFlowsoftheBaldwinCompany(continued)

Year0 Year1 Year2 Year3 Year4Year5Income:(8)SalesRevenues 100.00 163.00 249.72 212.20129.90

($thousands)(Allcashflowsoccurattheendoftheyear.)Recallthatproduction(inunits)byyearduring5-yearlifeofthemachineisgivenby:(5,000,8,000,12,000,10,000,6,000).Priceduringfirstyearis$20andincreases2%peryearthereafter.Salesrevenueinyear3=12,000×[$20×(1.02)2]=12,000×$20.81=$249,720.11TheWorksheetforCashFlowsoTheWorksheetforCashFlowsoftheBaldwinCompany(continued)

Year0 Year1 Year2 Year3 Year4Year5Income:(8)SalesRevenues 100.00 163.00 249.72 212.20129.90(9)Operatingcosts 50.00 88.00 145.20133.1087.84

($thousands)(Allcashflowsoccurattheendoftheyear.)Again,production(inunits)byyearduring5-yearlifeofthemachineisgivenby:(5,000,8,000,12,000,10,000,6,000).Productioncostsduringfirstyear(perunit)are$10and(increase10%peryearthereafter).Productioncostsinyear2=8,000×[$10×(1.10)1]=$88,00012TheWorksheetforCashFlowsoTheWorksheetforCashFlowsoftheBaldwinCompany(continued)

Year0 Year1 Year2 Year3 Year4Year5Income:(8)SalesRevenues 100.00 163.00 249.72 212.20129.90(9)Operatingcosts 50.00 88.00 145.20133.1087.84(10)Depreciation 20.00 32.00 19.20 11.5211.52($thousands)(Allcashflowsoccurattheendoftheyear.)DepreciationiscalculatedusingtheAcceleratedCostRecoverySystem(shownatright)Ourcostbasisis$100,000Depreciationchargeinyear4=$100,000×(.1152)=$11,520.Year ACRS% 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% Total 100.00% 13TheWorksheetforCashFlowsoTheWorksheetforCashFlowsoftheBaldwinCompany(continued)

Year0 Year1 Year2 Year3 Year4Year5Income:(8)SalesRevenues 100.00 163.00 249.72 212.20129.90(9)Operatingcosts 50.00 88.00 145.20133.1087.84(10)Depreciation 20.00 32.00 19.20 11.5211.52(11)Incomebeforetaxes 30.00 43.20 85.32 67.5830.54

[(8)–(9)-(10)](12)Taxat34percent 10.20 14.69 29.01 22.9810.38(13)NetIncome 19.80 28.51 56.31 44.6020.16

($thousands)(Allcashflowsoccurattheendoftheyear.)14TheWorksheetforCashFlowsoIncrementalAfterTaxCashFlows

oftheBaldwinCompany

Year0Year1Year2Year3Year4Year5(1)SalesRevenues

$100.00$163.00$249.72$212.20$129.90(2)Operatingcosts

-50.00-88.00-145.20133.10-87.84(3)Taxes

-10.20-14.69-29.01-22.98-10.38(4)OCF(1)–(2)–(3)

39.8060.5175.5156.1231.68(5)TotalCFofInvestment–260.

–6.32–8.653.75192.98(6)IATCF[(4)+(5)]–260.39.8054.1966.8659.87224.6605.588,51$)10.1(66.224$)10.1(87.59$)10.1(86.66$)10.1(19.54$)10.1(80.39$260$5432=+++++-=NPVNPV15IncrementalAfterTaxCashFloNPVBaldwinCompany139.8051,588.05–260CF1F1CF0INPV10154.19CF2F2166.86CF3F3159.87CF4F41224.66CF5F516NPVBaldwinCompany139.8051,587.3InflationandCapitalBudgetingInflationisanimportantfactofeconomiclifeandmustbeconsideredincapitalbudgeting.Considertherelationshipbetweeninterestratesandinflation,oftenreferredtoastheFisherrelationship:(1+NominalRate)=(1+RealRate)×(1+InflationRate)Forlowratesofinflation,thisisoftenapproximatedasRealRateNominalRate–InflationRateWhilethenominalrateintheU.S.hasfluctuatedwithinflation,mostofthetimetherealratehasexhibitedfarlessvariancethanthenominalrate.Whenaccountingforinflationincapitalbudgeting,onemustcomparerealcashflowsdiscountedatrealratesornominalcashflowsdiscountedatnominalrates.177.3InflationandCapitalBudgExampleofCapitalBudgetingunderInflation

SonyInternationalhasaninvestmentopportunitytoproduceanewstereocolorTV.TherequiredinvestmentonJanuary1ofthisyearis$32million.Thefirmwilldepreciatetheinvestmenttozerousingthestraight-linemethod.Thefirmisinthe34%taxbracket.ThepriceoftheproductonJanuary1willbe$400perunit.Thepricewillstayconstantinrealterms.Laborcostswillbe$15perhouronJanuary1.Thewillincreaseat2%peryearinrealterms.Energycostswillbe$5perTV;theywillincrease3%peryearinrealterms.Theinflationrateis5%Revenuesarereceivedandcostsarepaidatyear-end.18ExampleofCapitalBudgetinguExampleofCapitalBudgetingunderInflationTherisklessnominaldiscountrateis4%.Therealdiscountrateforcostsandrevenuesis8%.CalculatetheNPV.

Year1Year2Year3Year4PhysicalProduction(units)100,000200,000200,000150,000LaborInput(hours)2,000,0002,000,0002,000,0002,000,000Energyinput,physicalunits200,000200,000200,000200,00019ExampleofCapitalBudgetinguCF0ExampleofCapitalBudgeting

underInflationThedepreciationtaxshieldisarisk-freenominalcashflow,andisthereforediscountedatthenominalrisklessrate.Costofinvestmenttoday=$32,000,000Projectlife=4yearsAnnualdepreciationexpense:Depreciationtaxshield=$8,000,000×.34=$2,720,00042,720,0000CF1F19,873,315INPV4$8,000,000=$32,000,0004years20CF0ExampleofCapitalBudgetinYear1After-taxRealRiskyCashFlowsRiskyRealCashFlowsPrice:$400perunitwithzerorealpriceincreaseLabor:$15perhourwith2%realwageincreaseEnergy:$5perunitwith3%realenergycostincreaseYear1After-taxRealRiskyCashFlows:After-taxrevenues=$400×100,000×(1–.34)=$26,400,000After-taxlaborcosts=$15×2,000,000×1.02×(1–.34)=$20,196,000After-taxenergycosts=$5×2,00,000×1.03×(1–.34)=$679,800After-taxnetoperatingCF=$26,400,000–$20,196,000–$679,800=$5,524,20021Year1After-taxRealRiskyCaYear2After-taxRealRiskyCashFlowsRiskyRealCashFlowsPrice:$400perunitwithzerorealpriceincreaseLabor:$15perhourwith2%realwageincreaseEnergy:$5perunitwith3%realenergycostincreaseYear1After-taxRealRiskyCashFlows:After-taxrevenues=$400×100,000×(1–.34)=$26,400,000After-taxlaborcosts=$15×2,000,000×(1.02)2

×(1–.34)=$20,599,920After-taxenergycosts=$5×2,00,000×(1.03)2

×(1–.34)=$700,194After-taxnetoperatingCF=$26,400,000–$20,599,920–$700,194=$31,499,88622Year2After-taxRealRiskyCaYear3After-taxRealRiskyCashFlowsRiskyRealCashFlowsPrice:$400perunitwithzerorealpriceincreaseLabor:$15perhourwith2%realwageincreaseEnergy:$5perunitwith3%realenergycostincreaseYear1After-taxRealRiskyCashFlows:After-taxrevenues=$400×100,000×(1–.34)=$26,400,000After-taxlaborcosts=$15×2,000,000×(1.02)3

×(1–.34)=$21,011.92After-taxenergycosts=$5×2,00,000×(1.03)3

×(1–.34)=$721,199.82After-taxnetoperatingCF=$26,400,000–$21,011.92–$721,199.82=$31,066,88223Year3After-taxRealRiskyCaYear4After-taxRealRiskyCashFlowsRiskyRealCashFlowsPrice:$400perunitwithzerorealpriceincreaseLabor:$15perhourwith2%realwageincreaseEnergy:$5perunitwith3%realenergycostincreaseYear1After-taxRealRiskyCashFlows:After-taxrevenues=$400×100,000×(1–.34)=$26,400,000After-taxlaborcosts=$15×2,000,000×(1.02)4

×(1–.34)=$21,432.16After-taxenergycosts=$5×2,00,000×(1.03)4

×(1–.34)=$742,835.82After-taxnetoperatingCF=$26,400,000–$21,432.16–$742,835.82=$17,425,00724Year4After-taxRealRiskyCaExampleofCapitalBudgetingunderInflation$5,524,200

$31,499,886 $31,066,882 $17,425,007-$32,000,0000 1 2 3 415,524,000–32mCF1F1CF0131,499,886CF2F2131,066,882CF3F3117,425,007CF4F469,590,868INPV825ExampleofCapitalBudgetinguExampleofCapitalBudgeting

underInflation

TheprojectNPVcannowbecomputedasthesumofthePVofthecost,thePVoftheriskycashflowsdiscountedattheriskyrateandthePVoftherisk-freecashflowsdiscountedattherisk-freediscountrate.NPV=–$32,000,000+$69,590,868+$9,873,315=$47,464,18326ExampleofCapitalBudgeting

u7.3TheBoeing777:

AReal-WorldExampleInlate1990,theBoeingCompanyannounceditsintentiontobuildtheBoeing777,acommercialairplanethatcouldcarryupto390passengersandfly7,600miles.Analystsexpectedtheup-frontinvestmentandR&Dcostswouldbeasmuchas$8billion.Deliveryoftheplaneswasexpectedtobeginin1995andcontinueforatleast35years.277.3TheBoeing777:

AReal-WorTable7.5IncrementalCashFlows:Boeing777YearUnitsSalesRevenueOperatingCostsDep.TaxesDNWCCapitalSpendingInvest-mentNetCashFlow1991$865.00$40.00$(307.70)$400.00$400.00$(957.30)19921,340.0096.00(488.24)600.00600.00(1,451.76)19931,240.00116.40(461.18)300.00300.00(1,078.82)1994840.00124.76(328.02)200.00200.00(711.98)199514$1,847.551,976.69112.28(82.08)181.061.85182.91(229.97)199614519,418.9617,865.45101.06493.831,722.0019.421,741.42681.74199714019,244.2316,550.0490.95885.10(17.12)19.422.301,806.79NetCashFlowcanbedeterminedinthreesteps:Taxes ($19,244.23–$16,550.04–$90.95)×0.34=$885.10Investment –$17.12+$19.42=$2.30NCF $19,244.23–$16,550.04–$885.10–$2.30=$1,806.7928Table7.5IncrementalCashFlo1991

$(957.30)2002

$1,717.262013

$2,213.181992

$(1,451.76)2003

$1,590.012014

$2,104.731993

$(1,078.82)2004

$1,798.972015

$2,285.771994

$(711.98)2005

$616.792016

$2,353.811995

$(229.97)2006

$1,484.732017

$2,423.891996

$681.742007

$2,173.592018

$2,496.051997

$1,806.792008

$1,641.972019

$2,568.601998

$1,914.062009

$677.922020

$2,641.011999

$1,676.052010

$1,886.962021

$2,717.532000

$1,640.252011

$2,331.332022

$2,798.772001

$1,716.802012

$2,576.472023

$2,882.442024

$2,964.45YearYearYearNCFNCFNCF291991$(957.30)2002$1,7177.3TheBoeing777:AReal-WorldExamplePriorto1990,Boeinghadinvestedseveralhundredmilliondollarsinresearchanddevelopment.Sincethesecashoutflowswereincurredpriortothedecisiontobuildtheplane,theyaresunkcosts.TherelevantcostsweretheatthetimethedecisionwasmadeweretheforecastedNetCashFlows307.3TheBoeing777:AReal-WorNPVProfileoftheBoeing777ProjectThisgraphshowsNPVasafunctionofthediscountrate.Boeingshouldacceptthisprojectatdiscountrateslessthan21percentandrejecttheprojectathigherdiscountrates.IRR=21.12%31NPVProfileoftheBoeing777Boeing777Asitturnedout,salesfailedtomeetexpectations.InfairnesstothefinancialanalystsatBoeing,thereisanimportantdistinctionbetweenagooddecisionandagoodoutcome.32Boeing777Asitturnedout,sa7.4InvestmentsofUnequalLives:TheEquivalentAnnualCostMethodTherearetimeswhenapplicationoftheNPVrulecanleadtothewrongdecision.Considerafactorywhichmusthaveanaircleaner.Theequipmentismandatedbylaw,sothereisno“doingwithout”.Therearetwochoices:The“Cadillaccleaner”costs$4,000today,hasannualoperatingcostsof$100andlastsfor10years.The“Cheapskatecleaner”costs$1,000today,hasannualoperatingcostsof$500andlastsfor5years.Whichoneshouldwechoose?337.4InvestmentsofUnequalLivEACwithaCalculatorAtfirstglance,theCheapskatecleanerhasalowerNPV10–100–4,614.46–4,000CF1F1CF0INPV105–500–2,895.39–1,000CF1F1CF0INPV10CadillacAirCleanerCheapskateAirCleaner34EACwithaCalculatorAtfirst7.4InvestmentsofUnequalLives:TheEquivalentAnnualCostMethodThisoverlooksthefactthattheCadillaccleanerlaststwiceaslong.Whenweincorporatethat,theCadillaccleanerisactuallycheaper.357.4InvestmentsofUnequalLivTheCadillaccleanertimelineofcashflows:7.4InvestmentsofUnequalLives:TheEquivalentAnnualCostMethod-$4,000–100-100-100-100-100-100-100-100-100-100012345678910-$1,000–500-500-500-500-1,500-500-500-500-500-500012345678910TheCheapskatecleanertimelineofcashflowsovertenyears:36TheCadillaccleanertimelineTheEquivalentAnnualCostMethodWhenwemakeafaircomparison,theCadillacischeaper:10–100–4,614.46–4,000CF1F1CF0INPV104–500–4,693–1,000CF1F1CF0INPV10CadillacAirCleanerCheapskateAirCleaner1–1,500CF2F15–500CF3F137TheEquivalentAnnualCostMetInvestmentsofUnequalLivesReplacementChainRepeattheprojectsforever,findthePVofthatperpetuity.Assumption:Bothprojectscanandwillberepeated.MatchingCycleRepeatprojectsuntiltheybeginandendatthesametime—likewejustdidwiththeaircleaners.ComputeNPVforthe“repeatedprojects”.TheEquivalentAnnualCostMethod38InvestmentsofUnequalLivesReInvestmentsofUnequalLives:EACTheEquivalentAnnualCostMethodApplicabletoamuchmorerobustsetofcircumstancesthanreplacementchainormatchingcycle.TheEquivalentAnnualCostisthevalueofthelevelpaymentannuitythathasthesamePVasouroriginalsetofcashflows.NPV=EAC×ArTWhereArTisthepresentvalueof$1perperiodforTperiodswhenthediscountrateisr.Forexample,theEACfortheCadillacaircleaneris$750.98TheEACforthecheaperaircleaneris$763.80whichconfirmsourearlierdecisiontorejectit.39InvestmentsofUnequalLives:CadillacEACwithaCalculatorUsethecashflowmenutofindthePVofthe“l(fā)umpy”cashflows.Thenusethetimevalueofmoneykeystofindapaymentwiththatpresentvalue.10–100–4,614.46–4,000CF1F1CF0INPV10750.9810–4,614.4610PMTI/YFVPVNPV40CadillacEACwithaCalculatorCheapskateEACwithaCalculatorUsethecashflowmenutofindthePVofthecashflows.Thenusethetimevalueofmoneykeystofindapaymentwiththatpresentvalue.5–500–4,693.21–1,000CF1F1CF0INPV10763.8010–4,693.2110PMTI/YFVPVNPV41CheapskateEACwithaCalculatExampleofReplacementProjectsConsideraBelgianDentist’soffice;heneedsanautoclavetosterilizehisinstruments.Hehasanoldonethatisinuse,butthemaintenancecostsarerisingandsoisconsideringreplacingthisindispensablepieceofequipment.NewAutoclaveCost=$3,000today,Maintenancecost=$20peryearResalevalueafter6years=$1,200NPVofnewautoclave(atr=10%)is$2,409.74

EACofnewautoclave=-$553.2942ExampleofReplacementProjectExampleofReplacementProjectsExistingAutoclaveYear 0 1 2 3 4 5Maintenance 0 200 275 325 450 500Resale 900 850 775 700 600 500TotalAnnualCost TotalCostforyear1=(900×1.10–850)+200=$340340435TotalCostforyear2=(850×1.10–775)+275=$435478TotalCostforyear3=(775×1.10–700)+325=$478620TotalCostforyear4=(700×1.10–600)+450=$620TotalCostforyear5=(600×1.10–500)+500=$660660Notethatthetotalcostofkeepinganautoclaveforthefirstyearincludesthe$200maintenancecostaswellastheopportunitycostoftheforegonefuturevalueofthe$900wedidn’tgetfromsellingitinyear0lessthe$850wehaveifwestillownitatyear1.43ExampleofReplacementProjectNewAutoclaveEACofnewautoclave=-$553.29ExistingAutoclaveYear 0 1 2 3 4 5Maintenance 0 200 275 325 450 500Resale 900 850 775 700 600 500TotalAnnualCostExampleofReplacementProjects340435478620660Weshouldkeeptheoldautoclaveuntilit’scheapertobuyanewone.Replacetheautoclaveafteryear3:atthatpointthenewonewillcost$553.29forthenextyear’sautoclavingandtheoldonewillcost$620foronemoreyear.44NewAutoclaveExampleofReplac7.5SummaryandConclusionsCapitalbudgetingmustbeplacedonanincrementalbasis.SunkcostsareignoredOpportunitycostsandsideeffectsmatterInflationmustbehandledconsistentlyDiscountrealflowsatrealratesDiscountnominalflowsatnominalrates.Whenafirmmustchoosebetweentwomachinesofunequallives:thefirmcanapplyeitherthematchingcycleapproachortheequivalentannualcostapproach.457.5SummaryandConclusionsCapCHAPTER7NetPresentValue

andCapitalBudgeting46CHAPTER7NetPresentValue

andChapterOutline7.1IncrementalCashFlows7.2TheBaldwinCompany:AnExample7.3TheBoeing777:AReal-WorldExample7.4InflationandCapitalBudgeting7.5InvestmentsofUnequalLives:TheEquivalentAnnualCostMethod7.6SummaryandConclusions47ChapterOutline7.1Incremental7.1IncrementalCashFlowsCashflowsmatter—notaccountingearnings.Sunkcostsdon’tmatter.Incrementalcashflowsmatter.Opportunitycostsmatter.Sideeffectslikesynergyanderosionmatter.Taxesmatter:wewantincrementalafter-taxcashflows.Inflationmatters.487.1IncrementalCashFlowsCashCashFlows—NotAccountingEarningsConsiderdepreciationexpense.Youneverwriteacheckmadeoutto“depreciation”.Muchoftheworkinevaluatingaprojectliesintakingaccountingnumbersandgeneratingcashflows.49CashFlows—NotAccountingEarnIncrementalCashFlowsSunkcostsOpportunitycostsdomatter.JustbecauseaprojecthasapositiveNPVthatdoesnotmeanthatitshouldalsohaveautomaticacceptance.SpecificallyifanotherprojectwithahigherNPVwouldhavetobepassedupweshouldnotproceed.50IncrementalCashFlowsSunkcosIncrementalCashFlowsSideeffectsmatter.Erosion(Ifournewproductcausesexistingcustomerstodemandlessofcurrentproducts,weneedtorecognizethat.)Synergy51IncrementalCashFlowsSideeffEstimatingCashFlowsCashFlowsfromOperationsRecallthat:OperatingCashFlow=EBIT–Taxes+DepreciationNetCapitalSpendingDon’tforgetsalvagevalue(aftertax,ofcourse).52EstimatingCashFlowsCashFlowInterestExpenseLaterchapterswilldealwiththeimpactthattheamountofdebtthatafirmhasinitscapitalstructurehasonfirmvalue.Fornow,it’senoughtoassumethatthefirm’slevelofdebt(henceinterestexpense)isindependentoftheprojectathand.53InterestExpenseLaterchapters7.2TheBaldwinCompany:AnExample

Costsoftestmarketing(alreadyspent):$250,000. Currentmarketvalueofproposedfactorysite(whichweown):$150,000. Costofbowlingballmachine:$100,000(depreciatedaccordingtoACRS5-yearlife). Increaseinnetworkingcapital:$10,000. Production(inunits)byyearduring5-yearlifeofthemachine:5,000,8,000,12,000,10,000,6,000. Priceduringfirstyearis$20;priceincreases2%peryearthereafter. Productioncostsduringfirstyearare$10perunitandincrease10%peryearthereafter. Annualinflationrate:5% WorkingCapital:initially$10,000changeswithsales.547.2TheBaldwinCompany:AnExTheWorksheetforCashFlows

oftheBaldwinCompany

Year0 Year1 Year2 Year3 Year4Year5Investments:(1) Bowlingballmachine –100.00 21.76*(2) Accumulated 20.00 52.00 71.20 82.7294.24depreciation(3) Adjustedbasisof 80.00 48.00 28.80 17.285.76machineafter

depreciation(endofyear)(4) Opportunitycost –150.00 150.00

(warehouse)(5) Networkingcapital 10.00 10.00 16.32 24.97 21.22 0(endofyear)(6) Changeinnet –10.00 –6.32 –8.65 3.7521.22workingcapital(7) Totalcashflowof –260.00 –6.32 –8.65 3.75192.98investment

[(1)+(4)+(6)]*Weassumethattheendingmarketvalueofthecapitalinvestmentatyear5is$30,000.Capitalgainisthedifferencebetweenendingmarketvalueandadjustedbasisofthemachine.Theadjustedbasisistheoriginalpurchasepriceofthemachinelessdepreciation.Thecapitalgainis$24,240(=$30,000–$5,760).WewillassumetheincrementalcorporatetaxforBaldwinonthisprojectis34percent.Capitalgainsarenowtaxedattheordinaryincomerate,sothecapitalgainstaxdueis$8,240[0.34($30,000–$5,760)].Theafter-taxsalvagevalueis$30,000–[0.34($30,000–$5,760)]=21,760.($thousands)(Allcashflowsoccurattheendoftheyear.)55TheWorksheetforCashFlows

oTheWorksheetforCashFlowsoftheBaldwinCompany($thousands)(Allcashflowsoccurattheendoftheyear.)

Year0 Year1 Year2 Year3 Year4Year5Investments:(1) Bowlingballmachine –100.00 21.76*(2) Accumulated 20.00 52.00 71.20 82.7294.24depreciation(3) Adjustedbasisof 80.00 48.00 28.80 17.285.76machineafter

depreciation(endofyear)(4) Opportunitycost –150.00 150.00

(warehouse)(5) Networkingcapital 10.00 10.00 16.32 24.97 21.22 0(endofyear)(6) Changeinnet –10.00 –6.32 –8.65 3.7521.22workingcapital(7) Totalcashflowof –260.00 –6.32 –8.65 3.75192.98investment

[(1)+(4)+(6)]150Attheendoftheproject,thewarehouseisunencumbered,sowecansellitifwewantto.56TheWorksheetforCashFlowsoTheWorksheetforCashFlowsoftheBaldwinCompany(continued)

Year