Capital Budgeting Cash FlowsCapital Budgeting DecisionSlide 3Basic TerminologyRelevant Cash FlowsSlide 61. Initial Cash FlowSlide 82. Operating Cash FlowsSlide 103. Terminal Cash FlowSummarizing Relevant CFsCapital Budgeting Cash FlowsPrepared by Keldon BauerFIL 240Capital Budgeting Decision□Capital Budgeting:□The process of evaluating and selecting long-term investments.□Capital Expenditure:□An outlay expected to benefit the firm over at least 1 year.□Operating expenditures benefit the firm over a period less than 1 year.Capital Budgeting Decision□Steps in the Process:1. Proposal generation.2. Review and analysis.3. Decision making.4. Implementation.5. Follow-up.Basic Terminology□Independent versus Mutually Exclusive.□Unlimited Funds versus Capital Rationing.□Accept-Reject versus Ranking .□Conventional versus Non-Conventional Cash Flow Patterns.Relevant Cash Flows□Incremental Cash Flows:□Marginal cash flow associated with adopting the proposed “project.”□Major Cash Flow Components:1. Initial Cash Flow2. Operating Cash Flow3. Terminal Cash FlowRelevant Cash Flows□Expansion versus Replacement Decisions.□Sunk Costs and Opportunity Costs.□Sunk costs are ignored (incremental costs are zero).□Opportunity costs are includes, since they represent costs (or revenues) forgone.1. Initial Cash Flow□Cost of New Asset:□Include shipping and installation.□After-tax Proceeds from Sale of Old Asset:□Removal/Sale□Cleanup costs□Net of tax effect□Book value, tax profit (recaptured depreciation.1. Initial Cash Flow□Change in Net Working Capital.□Summary:Installed cost of new assetsAfter-tax proceeds from sale of old assets.Change in net working capitalInitial Cash Flow2. Operating Cash Flows□After-tax Incremental Cash Flows from Operations.□Be careful specific under replacement decisions.□Usually compared to not replacing now.□After-tax usually is “earnings” less the depreciation shielded tax.□Generally assume accelerated depreciation.□See page 94 for MACRS table.2. Operating Cash Flows□Summary:□Operating Cash Flow = NOPAT + Deprec.□See page 100.□If relevant, find the incremental cash flow, by finding the difference between the OCF for the proposed project and the OCF of the best alternative (what you are currently doing).3. Terminal Cash Flow□Proceeds from Sale of Assets□Net of sale, removal and cleanup.□Taxes on Sale of Assets□Book value and profit.□Change in Net Working Capital□Typically, setting net working capital back the way it was.Summarizing Relevant CFs□Use a cash flow timeline.□Rather than using the format presented in the text, bring net inflows and outflows down:□Make outflows negative,□Make inflows
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