Principles of Managerial Finance

CHAPTER 8 Capital Budgeting Cash Flows 371

TABLE 8.5 Powell Corporation’s Revenue and Expenses

(Excluding Depreciation) for Proposed and

Present Machines

With proposed machine With present machine

Expenses Expenses

Revenue (excl. depr.) Revenue (excl. depr.)

Year (1) (2) Year (1) (2)

1 $2,520,000 $2,300,000 1 $2,200,000 $1,990,000

2 2,520,000 2,300,000 2 2,300,000 2,110,000

3 2,520,000 2,300,000 3 2,400,000 2,230,000

4 2,520,000 2,300,000 4 2,400,000 2,250,000

5 2,520,000 2,300,000 5 2,250,000 2,120,000

LG5 8.4 Finding the Operating Cash Inflows

The benefits expected from a capital expenditure or “project” are embodied in its

operating cash inflows,which are incremental after-tax cash inflows.In this sec-

tion we use the income statement format to develop clear definitions of the terms

after-tax, cash inflows,and incremental.

Interpreting the Term After-Tax

Benefits expected to result from proposed capital expenditures must be measured

on an after-tax basis,because the firm will not have the use of any benefits until it

has satisfied the government’s tax claims. These claims depend on the firm’s tax-

able income, so deducting taxes beforemaking comparisons between proposed

investments is necessary for consistency when evaluating capital expenditure

alternatives.

Interpreting the Term Cash Inflows

All benefits expected from a proposed project must be measured on a cash flow

basis.Cash inflows represent dollars that can be spent, not merely “accounting

profits.” A simple accounting technique for converting after-tax net profits into

operating cash inflows was given in Equation 3.1 on page 102. The basic calcula-

tion requires adding depreciation and any other noncash charges(amortization

and depletion) deducted as expenses on the firm’s income statement back to net

profits after taxes. Because depreciation is commonly found on income state-

ments, it is the only noncash charge we consider.

EXAMPLE Powell Corporation’s estimates of its revenue and expenses (excluding deprecia-
tion), with and without the proposed new machine described in the preceding
example, are given in Table 8.5. Note that both the expected usable life of the
proposed machine and the remaining usable life of the present machine are 5
years. The amount to be depreciated with the proposed machine is calculated by