9- 1 fundamentals of corporate finance sixth edition richard a. brealey stewart c. myers alan j....
Post on 16-Dec-2015
224 Views
Preview:
TRANSCRIPT
9- 1
Fundamentals of Corporate
Finance
Sixth Edition
Richard A. Brealey
Stewart C. Myers
Alan J. Marcus
Slides by
Matthew Will
Chapter 8
McGraw Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved
Using Discounted Cash Flow Analysis to Make Investment
Decisions
9- 2
Topics Covered
Identifying Cash Flows Discount Cash Flows, Not Profits Discount Incremental Cash Flows Discount Nominal Cash Flows by the Nominal
Cost of Capitol Separate Investment & Financing Decisions
Calculating Cash Flows Example: Blooper Industries
9- 3
Cash Flow vs. Accounting Income
Discount actual cash flows Using accounting income, rather than cash flow,
could lead to erroneous decisions.
ExampleA project costs $2,000 and is expected to last 2
years, producing cash income of $1,500 and $500 respectively. The cost of the project can be depreciated at $1,000 per year. Given a 10% required return, compare the NPV using cash flow to the NPV using accounting income.
9- 4
500 -500 +Income Accounting
$1,000-$1,000-onDepreciati
500 $ $1,500 InflowCash
2Year 1Year
32.41$)10.1(
500
1.10
500=NPVApparent
2
Cash Flow vs. Accounting Income
9- 5
500 +1,500+2,000-FlowCash Free
2,000-CostProject
500 $ $1,500 InflowCash
2Year 1Year Today
14.223$)10.1(
500
)10.1(
500,12,000=NPVCash
2
Cash Flow vs. Accounting Income
9- 6
Incremental Cash Flows
Discount incremental cash flows Include All Indirect Effects Forget Sunk Costs Include Opportunity Costs Recognize the Investment in Working Capital Beware of Allocated Overhead Costs Remember Shutdown Cash Flows
Incremental Cash Flow
cash flow with project
cash flow without project= -
9- 7
Incremental Cash Flows
IMPORTANTIMPORTANT
Ask yourself this question
Would the cash flow still exist if the project does not exist?
If yes, do not include it in your analysis.If no, include it.
9- 8
Inflation
INFLATION RULEINFLATION RULE Be consistent in how you handle inflation!! Use nominal interest rates to discount
nominal cash flows. Use real interest rates to discount real cash
flows. You will get the same results, whether you
use nominal or real figures
9- 9
Inflation
Example
You own a lease that will cost you $8,000 next year, increasing at 3% a year (the forecasted inflation rate) for 3 additional years (4 years total). If discount rates are 10% what is the present value cost of the lease?
1 real interest rate = 1+nominal interest rate1+inflation rate
9- 10
Inflation
Example - nominal figures
$29,073
6,5688,742=8000x1.033
7,014487,8=8000x1.032
491,78,240=8000x1.031
00.000,880000
10% @ PVFlowCash Year
3
2
10.187423
10.184872
10.18240
9- 11
Inflation
Example - real figures
29,073
6,5688,0003
7,0148,0002
7,4918,0001
8,0008,0000
PV@6.7961%FlowCash Year
3
2
068.1
8,000068.1
8,000068.1
8,000
= $
9- 12 Separation of Investment & Financing Decisions
When valuing a project, ignore how the project is financed.
Following the logic from incremental analysis ask yourself the following question: Is the project existence dependent on the financing? If no, you must separate financing and investment decisions.
9- 13
Calculating Cash Flows
Think of cash flows as coming from three elements
Total cash flow =
+ cash flows from capital investments
+ cash flows from changes in working capital + operating cash flows
9- 14
Calculating Cash Flows
Cash Flow from Capital Investments Almost every project requires some sort of initial
investment. This is often capitalized from an accounting perspective. In finance, the investment represents a negative cash flow.
9- 15
Calculating Cash Flows
Operating Cash Flow Operating cash flow =
+ Revenue
- Costs
- Taxes Methods of Handling Depreciation
• Method l: Dollars in Minus Dollars Out
• Method 2: Adjusted Accounting Profits
• Method 3: Add Back Depreciation Tax Shield
9- 16
Blooper Industries
650,2462,2283,2113,2950,1Profit
427,1326,1230,1137,1050,1(35%).Tax
078,4788,3513,3250,3000,3ProfitPretax
000,2000,2000,2000,2000,2onDepreciati
155,12576,11025,11500,10000,10Expenses
233,18364,17538,16750,15000,15Revenues
039,3679,1225214204575,2500,1in WC Change
0039,3717,4493,4279,4075,4500,1WC
00010Invest Cap
6543210Year
,
(,000s)
9- 17
Blooper Industries
Cash Flow From Operations (,000s)Revenues
- Expenses
Depreciation
= Profit before tax
.-Tax @ 35 %
= Net profit
+ Depreciation
= CF from operations
15 000
10 000
2 000
3 000
1 050
1 950
2 000
3 950
,
,
,
,
,
,
,
,
or $3,950,000
9- 18
Blooper Industries
Net Cash Flow (entire project) (,000s)
4,3396,3294,2384,0693,9091,37511,500-FlowCash Net
4,6514,4624,2834,1133,950Op from CF
039,31,679225-214-204-2,575-1,500-in WC Change300,1
10,000-
valueSalvage
Invest Cap6543210Year
NPV @ 12% = $4,222,350
9- 19
Web Resources
top related