374 Part 4 Investing in Long-Term Assets: Capital Budgeting
(^4) Some professors may choose to cover some of the risk sections (12-4 through 12-6) and skip others. We o# er a
range of choices, and we tried to make the exposition clear enough that interested and self-motivated students
can read sections on their own even if the sections are not assigned.
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A B C D E F G H I
Part I. Net Cash Flows Before Replacement
Part II. Net Cash Flows After Replacement
Part III. Incremental Cash Flows and Evaluation
Part IV. Alternative (Streamlined) Calculation for NCF
Incremental CFs = CF After - CF Before
Project Evaluation @ WACC =
Sales revenues
Costs except depreciation
Depreciation
Total operating costs
Operating income
Taxes 40%
After-tax operating income
Add back depreciation
Net cash !ows before replacement
New machine cost
After-tax salvage value, old machine
Sales revenues
Costs except depreciation
Depreciation
Total operating costs
Operating income
Taxes 40%
After-tax operating income
Add back depreciation
Net cash !ows after replacement
10%
NPV =
IRR =
MIRR =
Payback =
$80.28
12.51%
11.35%
2.76
-$2,000
400
$600
360
$600
360
$600
360
$600
360
560
224
800
320
200
80
40
16
-$1,600
-$1,600 $584 $680 $440 $376
-$2,000
$400
-$1,600
-$1,600 $584 $680 $440 $376
New machine cost
Salvage value, old machine
Net cost of new machine
Cost savings = Old - New
A-T savings = Cost savings! (1 - Tax rate)
! Depreciation = (New - old)
Depr’n tax savings =! Depreciation! Tax rate
NCF = A-T cost savings + Depr’n tax savings
$2,500
1,000
100
$1,100
$1,400
560
$840
100
$940
$2,500
1,000
100
$1,100
$1,400
560
$840
100
$940
$2,500
1,000
100
$1,100
$1,400
560
$840
100
$940
$2,500
1,000
100
$1,100
$1,400
560
$840
100
$940
0 1 2 3 4
$2,500
400
660
$1,060
$1,440
576
$864
660
$1,524
$2,500
400
900
$1,300
$1,200
480
$720
900
$1,620
$2,500
400
300
$700
$1,800
720
$1,080
300
$1,380
$2,500
400
140
$540
$1,960
784
$1,176
140
$1,316
Tabl e 12 - 2 Replacement Project R
12-4 RISK ANALYSIS IN CAPITAL BUDGETING
4
Projects differ in risk, and risk should be re! ected in capital budgeting decisions.
However, it is dif" cult to measure risk, especially for new projects where no his-
tory exists. For this reason, managers deal with risk in many different ways,
ranging from almost totally subjective adjustments to highly sophisticated analy-
ses that involve computer simulation and high-powered statistics.