10: Cash Flow and Capital Budgeting10-3a YEAr 0 CASH FLOW
The company will have cash outlays of $50,000 for computer equipment immediately (year 0). The
company will also have a cash outlay of $3,000 for its net investment in working capital. That consists
of outflows of $1,000 to increase the cash balance and $4,500 to purchase inventory, and an inflow of
$2,500 from an increase in trade credit. Therefore, the net cash flow for year 0 is:
Increase in fixed assets –$50,000
Increase in working capital –$ 3,000
Total cash outflow –$53,000Notice that we do not include the $10,000 that Protect IT spent studying the potential market for
covers for tablet devices. That is a sunk cost that cannot be recovered, even if the company decides not
to pursue this investment, so it is not an incremental cash flow.
10-3b YEAr 1 CASH FLOW
In year 1, the project earns after-tax income of $655. To determine cash flows, we add back the non-cash
depreciation charge of $10,000. There is no new investment in fixed assets in year 1, but the net working
capital balance rises from $3,000 to $10,283. This represents a cash outflow of $7,283, which consists
of the following components:
Year 0 Year 1
Cash $ 1,000 $ 2,000
Accounts receivable 0 5,063
Inventory 4,500 7,594
Accounts payable –2,500 –4,374
Net working capital $ 3,000 $10,283You can calculate the net cash outflow from new investments in working capital on an item-by-item
basis as follows:
Outflows
Increase in cash $1,000
Increase in accounts receivable 5,063
Increase in inventory 3,094
Total working capital outflows $9,157
Inflows
Increase in accounts payable $1,874
Net cash flow from working capital = inflows – outflows = –$7,283Summing up, the incremental cash flows for year 1 are as follows:
Net income $ 655
Depreciation 10,000
Net working capital –7,283
Net cash flow $ 3,372