FINA211 WK7-8 L13-16 Capital Budgeting Flashcards
What is the accounting identity?
Assets = Liabilities + Owners’ Equity
What is the cash flow identity?
Cash Flow From Assets = Cash Flow to Creditors + Cash Flow to Shareholders
CFFA = CFTC + CFTST
What is the formula for CFTC?
CFTC = Interest Paid - New Debt + Debt Retired
CFTC = Interest Paid - (New Debt - Debt Retired)
CFTC = Interest Paid - Net New Debt
CFTC is to be looked at from the perspective of creditors. Is it a cash inflow to or a cash outflow from creditors?
Interest paid is a cash inflow for creditors and is therefore positive. This is the same for debt retired.
New debt is a cash outflow from creditors and is therefore negative.
What is the formula for CFTS?
CFTS = Dividends - New Issues + Repurchases
CFTS = Dividends - (New Issues - Repurchases)
CFTS = Dividends - Net New Equity
CFTS is to be looked at from the perspective of the
What are the two formulas for CFFA?
- CFFA = CFTC + CFTS
- CFFA = OCF - NCS - Change In NCS
What is the formula for CFTS?
CFTS = Dividends - New Issues + Repurchases
CFTS = Dividends - (New Issues - Repurchases)
CFTS = Dividends - Net New Equity
CFTS is to be looked at from the perspective of shareholders. Is it a cash inflow to or a cash outflow from shareholders?
Dividends is a cash inflow for shareholders and is therefore postive. This is the same for repurchases.
New issues are a cash outflow for shareholders and is therefore negative.
What are the three formulas for OCF?
OCF top down = SALES - COGS - SGAE - TAXES
OCF bottom up = NI + DEP
OCF tax shield = (SALES - COGS - SGAE)(1-TR) + DEPTR
What formula do you need to know for NCS calculations besides the initial investment amount?
Salvage Value after tax = Market Value(1-TC) + Book ValueTC
For situations in which the price at which the asset was sold was higher than the book value resulting in the difference being treated as depreciation recovery income meaning. Too much depreciation was claimed on the asset meaning that the firm was able to claim this depreciation as a deduction resulting in the firm paying less tax. The depreciation recovery income is therefore taxable.
What is the formula for change in NWC?
However,
NWC = (CA t - CA t-1) - (CL t - CL t-1)
NWC = Change in CA - Change in CL
NWC is usually given
Assume NWC is fully recovered at the end of the project’s life if not explicitly stated otherwise.
What is the NPV of a project?
The NPV of a project is equal to the PV of all the CFFA of the entire project from t=0 to t=n
NPV = - PV CFFA t=0 + PV CFFA t=0 to t=n
How do you approach a capital budgeting question where cost reductions is a factor?
Cost Reductions increases EBT. Tax also increases.
Cost Reductions- DEP = Increase in EBT
Increase in EBT*TR = Increase in TAXES
Cost Reductions - Increase in TAXES = Increase in OCF
The increase in OCF is the OCF to be used in the question if no SALES, COGS, or SGAE are included in the question.
If cost reductions appear in a question, it is unlikely that SALES, COGS, or SGAE will be included.
How do you calculate the Equivalent Annual Cost (EAC) of a project?
To calculate the EAC of a project, firstly you must calculate the NPV of the project.
To calculate the EAC of a project, use the PV annuity formula, substitute the NPV of the project as the PV and solve for C.
EAC = C = (NPV/(1-(1/(1+r)^t)))*r
Equivalent annual cost (EAC) is the annual cost of owning, operating, and maintaining an asset over its entire life. EAC is often used by firms for capital budgeting decisions, as it allows a company to compare the cost-effectiveness of various assets that have unequal lifespans.
How do you approach a capital budgetting question where the price/sales/OCF is unknown?
Approach the question as you would normally while leaving price/sales/OCF as an unknown variable
Write out the formula for CFFA
Use algebra to solve
For cases where price and sales is unknown but output is known:
Move CFFA t=0 over to the left side
Place square brackets around the portion of the equation relating to solving the PV of CFFA after t=0
Factor out OCF from inside the brackets to the outside of the square brackets and replace the numerators of the fractions with 1
Simplify
Solve for OFC
Substitute into the equation for OFC to solve for SALES
Divide SALES by output for price
What is the difference between nominal and real values?
Nominal values are based on current monetary values, whereas real values are adjusted for inflation based
How do you convert a nominal value to a real value?
x/(1+IR)^t
where IR is the inflation rate
