Ch 10- Marketing Cap Inv Decision Flashcards
Gross Margin- Depreciation
EBIT
When you are creating the financial model, you need to calculate the EBIT of every year
imagine if you have 20 years then you need a lot of EBITs- how to address this problem?
USE THE TAX SHIELD
PV CCA TS
Present value of the tax shield on cca
d= CCA rate
the last tern (SndTc/ (D+r) os equal to the salvage value
10.4 Example
TRICK ON THE EXAM: DELIVERY AND INSTALLATION COSTS, ARE THEY CAPITALIZED OR EXPENSED?
CAPITALIZE IT!!!!
How do we determine what is a relevant and irrelevant cash flow?
It has to incremental! meaning that these are CF that DEPEND on taking on the project :)
WE IGNORE THE CF THAT WOULD EXIST REGARDLESS OF US TAKING ON THE PROJECT OR NOT
What is the stand alone principle
HELPS US BASICALLY ANALYZE A PROJECT
Comparing the cash flow of firm to the cost of acquiring it on a small scale (hard to compute the cf of a huge firm before and after 1 project)
What is a sunk cost
a cost that has already been paid/incurred
it can not go away if we decide to say yes/no to a new project
-> THESE ARE NOT INCREMENETAL CASH FLOWS!!! WILL OCCUR NO ATTER WHAT SO EXCLUDE THEM
Opportunity cost
the cost of giving up another alternative!
firms might own certain equipment for a project, and thus they dont need to buy any new one- so is their equipment free? no! they could have been used elsewhere but they arent
also, how should the opp cost be priced? = the current selling price net of selling costs
Side Effects:
-erosion
-benefits
when pursuing a project nefatively impacts aother projects cash flows
when it helps you make more cash flows
Do we care about NWC in investing projects?
YES! because we need the cash on hand to do the actual intiial investmetn and also for any costs that come up
Financing costs- consideratin for investing
we do not consider this because wec are about the CF generated by the assets
***INTEREST PAID IS A BGI COMPONENT OF CF TO CREDITORS NOT CF FROM ASSETS
inflaiton needs to be ocnsidered too
word
When do we measure cf
when it actually occurs not when it arises in the acct sense
Do we care about pre tax or after tax cf
after tax!!!!
What is Pro Forma FS
projected FS
Simplifying asusmptions in PRO forma FS
- straight line depreciaiton not CCA
- full year depreciaiton = taken in first year
- projects MV = BV when scrapped
What do you need to create pro forma FS
estimates of quantities (unit sales, sell price per unit, vbl cost per unit, total fixed costs)
- need to know total investment required
(including any investnment in NWC)
How to make Pro Forma FS
Sales
-Vbl Costs
=Gross Profit
Fixed Costs
-Depreciation
=EBIT
-Taxes
=NI
**no interest dediuctions bc interest paid is a cf to creditors
How to get a projects cash flows
based on OCF formula
PCF= ProjectOperating CF- ProjectAddtoNWC - ProjectCapSpending
How to calculate Project Operating Cash Flow
Use projects info
OCF= EBIT+DEP-taxes
How to get Project NWC and Project Cap Spending
change in nwc
what is net cash flow
Change in CA -Change in CL
S - C - Change in NWC
When you have an investmetni n net working capital, what is the one thing to know about it?
IT MUST BE RECOVERED WHOLLY
What is Cash Inflow
Sales- Increase in A/R
A/r is a non cash expense bestie
How to break down a lot of information and see if you should proceed with a project?
- Calculate projected sales
- Revenue, Variable Costs, Fixed Costs, CCA/Dep, EBIT, Taxes, NI table
-> Make sure to get CCA correctly - Calc OCF (EBIT+CCA-Taxes for EVERY YEAR)
- Calc NWC for every year (Initial NWC for Y1, NWC increases yearly, NWC recovery in Ylast)
- Look at sale price of equipment, is it >Adj Cost or <Adj cost (This will be salvage)
- OCF + Additions to NWC - Cap Spend= Total project CF
- Discount all Cash flows
- Get NPV, IRR, Payback; should we accept or reject the project
Wat is an increase in NWC
Cash outflow
What is a decrease in NWC
Cash inglow (- sign as cash is returning to the firm)
4 ways of calculating OCF
- REGULAR: OCF= EBIT+DEP-TAX
- Bottom Up: OCF= NI+Dep
-start w bottom line (N1) and add back
-only correct when no int expenses subtracted in calc of NI - Top Down: OCF= Sales-Costs-Taxes
- Start at top of SOCI, leave out non cash - Tax shield approach:
OCF= (Sales-Costs)(1-Tax)+Dep*Tax
ALL correct whiever is more ocnvenitnet use it
Why do we like tax shield
we always need CCA, ebit, and NI figures and this is most efficient
How to Apply Tax Shield approach?
- find the PV of each source of cash flows and add them
2.(S-C)(1-Tc)+DTc
When to use the PV of Tax shield on CCA and when to not use it?
This makes it easier you dont even gotta calculate the yearly CCA
->MAIN IDEA: tax shields from CCA continue in perpetuity as long as there are assets remaining in CCA class (As long as its open)
BUT YOU CAN NOT USE THIS FORMULA IF YK THE ASSET POOL WILL BE CLOSED AT THE END OF THE PROJECTS LIFE
-> if this is the case, annual CCA should be calculated to get the UCC and find if terminal loss or CCA recapture
Why is the salvage value diff from UCC
There is a slight difference between this calculation for the present value of the tax shield on CCA and what
we got in Table 10.12 by adding the tax shields over the project life. The difference arises whenever the
salvage value of the asset differs from its UCC. When an asset is sold, the difference between its salvage
value and ending UCC is not realized as gain or loss on the statement of comprehensive income
immediately. It remains in the asset pool and continues to create CCA tax shields for as long as the pool
exists. Hence, the formula solution is more accurate as it takes into account the future CCA on this
difference
PVCCATS FORMULA
4 special cases of DCF analysis
- investments for improving efficieny and cutting costs
- analyzing replacement deciisions
- choosingn b/w equipment w diff economic lives
- when a firm is competing bids
Type 1 case of DCF Analysis: Cost cutting proposals
Issue: is the cost savings enough to justify expense?
How to solve?
- find incremental CF (make a table, what is the first investment, is there NWC consequences?, what are the effects on operating CF)
- get PV CCATS
- get PVCASH flows
- get the NPV
THIS IS THE BASIC ONE
Type 2 case of DCF Analysis: Replacing an Asset
REPLACING ASSETS! LOOK AT TABLE
How to know if we should include the cf or not?
Ask the question, will this cash flow occur or not occur ONLY if we accept the project?
YES= include it
Part of it=include only the part that will occur
Why do we have to consider changes in NWC separtely
GAAP! record sales when made not when cash recievied and also we nee to buy inventory to support sales evn though we dont have the cash yet
What is the depreciation tax shield
D*T (dep expense * marginal tax rate)
Type 3 case of DCF Analysis: evaluating equipment w diff lives
Setting the bid pirce
what is net working capital at its most basic
this is the cash in the till
when are taxes deducted
before cash flows
financing costs are not included in net working capital
!
what are the two things we spend money on in a project?
initial fixed assets + net working cpaital investement = total outflow
we recover investment in net working cpaital in our last year
how to measure cash in?
how to measure cash out?
total cash collections
sales - a/r (non cash)
costs - inventories decrease + payables decreasing
total cash collections: cash in-cash out
an increase in NWC is
cash outflow
a decrease in NWC is
cash inflow
cash outflow
costs - increase in a/p + increase in inventory
