1 / 9

NPV of a Project Relevant Cash Flows Pro Forma Financial Statements Evaluating NPV Estimates

Ch. 9: Making Capital Investment Decisions. NPV of a Project Relevant Cash Flows Pro Forma Financial Statements Evaluating NPV Estimates Real Options Capital Rationing. NPV of a Project. See Table 9.14 on p. 256 Calculate relevant net cash flow for each period

jara
Download Presentation

NPV of a Project Relevant Cash Flows Pro Forma Financial Statements Evaluating NPV Estimates

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Ch. 9: Making Capital Investment Decisions • NPV of a Project • Relevant Cash Flows • Pro Forma Financial Statements • Evaluating NPV Estimates • Real Options • Capital Rationing

  2. NPV of a Project • See Table 9.14 on p. 256 • Calculate relevant net cash flow for each period • Discount by WACC, if project’s risk is similar to firm’s (Ch. 12) • Adjust WACC up or down if project’s risk is significantly higher or lower (Ch. 12)

  3. Relevant Project Cash Flows • Use aftertax incremental cash flows: any change in the firm’s future cash flows because of the project, including side effects. • Exclude sunk costs. • Use opportunity cost: the most valuable alternative given up if the project is undertaken. • Since WACC includes inflation, so should projected cash flows (i.e., they should be nominal). • Project’s cash flow = + project’s operating cash flow - project’s change in net working capital - project’s capital spending

  4. Relevant CFs (cont.) • Exclude financing costs from cash flows (interest expense, principal payments, dividends) because they are already in WACC • Ex.: One-year project, initial cost = $100. Borrow $100 at 10% (WACC) for a year; ignoring taxes, need to make $110 to break even (NPV=0): NPV = -$100 + $110/1.10 -CORRECT • If we incorrectly deduct financing cost from Year 1 cash flow, we would be double-counting: NPV = -$100 + $(110-10)/1.10 = -$9.09 -WRONG

  5. Pro Forma Financial Statements • See Tables 9.9 - 9.14 on pp. 253-6 • Project’s cash flow = + project’s operating cash flow - project’s change in net working capital - project’s capital spending • Project’s operating cash flow = EBIT + depreciation - taxes • Depreciation: see next slide • Subtract project’s change in net working capital • Subtract project’s capital spending

  6. Net Salvage Value • net salvage value = salvage (market) value - taxes • taxes = tax rate * gain on sale • gain on sale = salvage (market) value - book value • book value = original depreciable basis - accumulated depreciation • MACRS Tables 9.6 & 9.7, p. 250 Book Value versus Market Value The Half-year convention implies 7-year asset depreciated over 8 years, etc.

  7. Evaluating NPV Estimates • Cash flows are estimates into the future • Forecasting (estimation) risk: the possibility that errors in projected cash flows will lead to incorrect decisions • Analyze sources of project’s value • Scenario analysis: base case, optimistic case, pessimistic case • Sensitivity analysis: see how sensitive the NPV conclusion to one variable by varying it while using base case for all other inputs.

  8. Real Options, Capital Rationing • Real (a.k.a. managerial, embedded) options • option to expand, option to abandon, option to wait, strategic options • Capital rationing: funds are not available for a project with positive NPV

  9. Recommended Practice • Self-Test Problems 9.1 & 9.2 on pp. 266-7 • Questions 2, 3, 7-9 (starts after 6), 12 on pp. 267-8 • Problems on pp. 268-71: 1, 7, 9-12, 19, 21 (most answers are on p. 548)

More Related