ACCT 2102 Lecture 2 Outline of Last LectureI. Capital Budgeting ProcessII. Cost of CapitalIII. Cost of DebtIV. Cost of EquityV. Weighted Average Cost of CapitalVI. Net Present Value Method of Capital BudgetingVII. Net Present Value AnalysisOutline of Current LectureI. Cash FlowsA. Importance of Cash FlowsB. Sources of Cash FlowsC. Calculation of SourcesII. Depreciation A.Overview of DepreciationB.Methods of Depreciation III. After-Tax Cash FlowsA. Computation of After-Tax Cash FlowsCurrent LectureCash Flows: o When a business has an increase in revenues (assets) or a decrease in expenses (liabilities), there in an increase in net income. o Generally, this increase in net income increases cash flows.o Remember: Net income ≠ Cash flow Sources of Cash Inflowo Along with increasing cash flow, an increase in net income causes an increase in taxes.o Due to this increase, for NPV analysis, we use after-tax cash inflows.o You must account for depreciation. It is a huge non-cash expense.These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.o The importance of depreciation is that although it does not affect cash it affects taxes and generate tax savings.Calculating after-tax cash flow (ATCF): Step 1: pre-tax cash flow*tax rate= taxes being paidStep 2: pre-tax cash flow – taxes being paid = ATCF Ex: A company’s pre-tax cash flows for the year are $100,000 and its income tax rate is 35%. Step 1: $100,000*.35 = $35,000 Step 2: $100,000 – $35,000 = $65,000Your after-tax cash flow is $65,000. Depreciation:o At some point the assets we’ve purchased and capitalized on become used up.o Definition of depreciation: the process of expensing the costs of an asset over the periods in which the asset was used to help produce revenues (accounting for the “using up” of the asset).o Useful life is the time period which the assets generate revenues.o Depreciation is an example of the matching principle, in which under the accrual-basis of accounting, expenses are reported in the same period as the revenues they helped produce.Methods of Depreciation:o There are different methods to calculate depreciation, but the straight-line method is what we will use the most.o The straight-line method spreads the asset’s depreciable cost evenly over useful life.Formula: Salvage value is what you expect to sell the asset for when you are finished using it.AnnualDepreciation=Cost - Salvage ValueUseful Life =Depreciable CostUseful LifeEx: A copier with a cost of $57,000 has an estimated salvage value of $5,000 and a usefullife of 4 years. Compute depreciation expense and carrying value for each of the four years.Ex: An asset will cost $100,000 and be used for 10 years. It is depreciated uniformly overits life and the tax rate is 25%. What is the annual tax shield? (amount shielded from taxes)Step 2: $100,000 / 10 years = $10,000 depreciationStep 1: $10,000 * 0.25 = $2,500 tax shield$57,000 - $5,000 = $13,000 4AnnualDepreciation=Cost - Salvage ValueUseful