Evaluating Capital Budgeting Projects 309
TABLE 8-3 Analysis of a New (Expansion) Project
Part 3
expected sale price minus the tax liability or plus the credit. Thus, the firm expects
to net $8,863 from the sale of the building and $1,744 from the equipment, for a
total of $10,607.
Next, in Part 4, we use the information developed in Parts 1, 2, and 3 to find the
projected cash flows over the project’s life. Five periods are shown, from Year 0 (2003)
to Year 4 (2007). The cash outlays required at Year 0 are the negative numbers in
Column E for 2003, and their sum, $26,000, is shown at the bottom in cell E105.
Then, in the next four columns, we calculate the operating cash flows. We begin with
sales revenues, found as the product of units sold and the sales price. Next, we subtract
variable costs, which were assumed to be $2.10 per unit. We then deduct fixed operat-
ing costs and depreciation to obtain taxable operating income, or EBIT. When taxes
(at a 40 percent rate) are subtracted, we are left with net operating profit after taxes, or
NOPAT. Note, though, that we are seeking cash flows, not accounting income. Thus,
depreciation must be added back.
RIC must purchase raw materials and replenish them each year as they are
used. In Part 1 we assume that RICmust have an amount of NOWC on hand
equal to 10 percent of the upcoming year’s sales. For example, sales in Year 1 are
$60,000, so RIC must have $6,000 in NOWC at Year 0, as shown in Cell E97.
Because RIC had no NOWC prior to Year 0, it must make a $6,000 investment
in NOWC at Year 0, as shown in Cell E98. Sales increase to $61,200 in Year 2,
so RIC must have $6,120 of NOWC at Year 1. Because it already had $6,000 in
NOWC on hand, its net investment at Year 1 is just $120, shown in Cell F98.
Note that RIC will have no sales after Year 4, so it will require no NOWC at
Year 4. Thus, it has a positive cash flow of $6,367 at Year 4 as working capital is
sold but not replaced.
308 Cash Flow Estimation and Risk Analysis
