Fundamentals of Financial Management (Concise 6th Edition)

Chapter 12 Cash Flow Estimation and Risk Analysis 369

12-2 ANALYSIS OF AN EXPANSION PROJECT

In Chapter 11, we analyzed two projects, S and L. We were given the cash! ows
and used them to illustrate how the NPV, IRR, MIRR, and payback are calculated.
Now we demonstrate how cash! ows are actually estimated, using our old
Project S to demonstrate the procedure. We explain the process in Table 12-1. Look
at it as we discuss the analysis. Note that the dollars are in thousands; we omitted

Tabl e 12 - 1 Cash Flow Estimation and Analysis for Expansion Project S

1 2 3 4 5 6 7 8 9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

A B C D E F G H I

Investment Outlays at Time = 0

Net Cash Flows Over the Project’s Life

Equipment

Net WC

Unit sales

Sales price

Variable cost per unit

Sales revenues = Units! Price

Variable costs = Units! Cost/unit

Fixed operating costs except depr’n

Depreciation: Accelerated from table below

Total operating costs

EBIT (or operating income)

Taxes on operating income 40%

After-tax project operating income

Add back depreciation

Salvage value (taxed as ordinary income)

Tax on salvage value (SV is taxed at 40%)

Recovery of net working capital

Project net cash !ows (Time Line)

537

$10.00

$5.092

$5,370

2,735

2,000

297

$5,032

$338

135

$203

297

520

$10.00

$5.391

$5,200

2,803

2,000

405

$5,208

-$8

-3

-$5

405

505

$10.00

$5.228

$5,050

2,640

2,000

135

$4,775

$275

110

$165

135

490

$10.00

$6.106

$4,900

2,992

2,000

63

$5,055

-$155

-62

-$93

63

50

-20

100

$100

-$900

-100

-$1,000

0 1 2 3 4

$500 $400 $300

Depreciation

Alternative depreciation

Project Evaluation @ WACC = 10%

Accelerated

Rate

Depreciation

Straight line

Rate

Depreciation

1

33%

$297

45%

$405

15%

$135

7%

$63

Cost: $900

Cost: $900

Accelerated

NPV

IRR

MIRR

Payback

$78.82

14.489%

12.106%

2.33

=NPV(D29,F22:I22)+E22

=IRR(E22:I22)

=MIRR(E22:I22,D29,D29)

=G2+(-E22-F22-G22)/H22

$64.44

13.437%

11.731%

2.60

Formulas Straight line

2 3 4

25%

$225

25%

$225

25%

$225

25%

$225

2. If the "rm owned assets that would be used for the project but would be sold if the project is not accepted, the
   after-tax value of those assets would be shown as an ”opportunity cost” in the ”Investment Outlays” section.


3. If this project would reduce sales and cash !ows from one of the "rm's other divisions, then the after-tax cannibalization
   e#ect, or ”externality,” would be deducted from the net cash !ows shown on Row 22.


4. Accelerated depreciation rates are set by Congress. We show the approximate rates for a 4-year asset in 2008.
   Companies also have the option of using straight-line depreciation. Under IRS rules, salvage value is not deducted when
   establishing the depreciable basis. However, if a salvage payment is received, it is called a recapture of depreciation
   and is taxed at the 40% rate.


5. If the "rm had previously incurred costs associated with this project, but those costs could not be recovered
   regardless of whether this project is accepted, then they are ”sunk costs” and should not enter the analysis.

35

36

37

38