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Chapter 10 Incremental Cash Flow. Three Financial Statements Fundamental Accounting Relationship Cash Flow Identity to Sources and Uses Estimating Incremental Cash Flow Capital Spending and Depreciation Disposal of Capital Equipment Projected Cash Flow for Project.

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chapter 10 incremental cash flow
Chapter 10Incremental Cash Flow
  • Three Financial Statements
  • Fundamental Accounting Relationship
  • Cash Flow Identity to Sources and Uses
  • Estimating Incremental Cash Flow
  • Capital Spending and Depreciation
  • Disposal of Capital Equipment
  • Projected Cash Flow for Project
three financial statements
Three Financial Statements
  • Income Statement – Measure of performance over a specific time
  • Statement of Financial Position or Balance Sheet – Listing of all assets, liabilities, and ownership claims
  • Sources and Uses of Cash or Statement of Cash Flow – Where dollars came from and where dollars were spent
three financial statements3
Three Financial Statements
  • Income Statement bottom line is net income
  • Net income is not cash flow
    • Accrual Accounting – timing of cash and recording of economic transaction different
    • Noncash items – depreciation for example
  • Want operating cash flow (OCF)
    • Use modified income statement
    • Interest expense is not part of OCF
three financial statements4
Three Financial Statements
  • The Balance Sheet Categories
    • Cash Account
      • Key element is change in cash over the period
      • Cash includes money, checking accounts, etc.
    • Working Capital Accounts
      • Current Assets and Current Liabilities
      • Assets and Liabilities typically converted to cash or paid over the business cycle
    • Long-Term Debt
    • Owner’s Accounts
  • Snapshot of company at a specific point in time
three financial statements5
Three Financial Statements
  • Statement of Cash Flow or Sources and Uses of Cash
    • Cash flow from business operations
    • Cash flow from financing
      • From Owners (residual claims)
      • From Lenders (fixed claims)
    • Cash flow for capital spending
      • Purchase of capital equipment
      • Recapture cash from sale of assets
  • Ties to the change in Cash Account over the period
fundamental accounting relationship
Fundamental Accounting Relationship
  • Accounting Identity in two forms
    • Assets ≡ Liabilities + Owner’s Equity
    • Cash Flow from Assets ≡ Cash Flow to Creditors + Cash Flow to Owners
  • Building the Cash Flow Identity
    • Cash Flow from Assets = Operating Cash Flow – Increases in Net Working Capital – Increases in Capital Spending
    • Work through components, pages 269-271
fundamental accounting relationship7
Fundamental Accounting Relationship
  • Continued Building the Cash Flow Identity
    • Cash Flow to Creditors
      • Interest paid on debt – shows up in this section not in operating cash flow
      • Any repayment of principal on debt claims
    • Cash Flow to Owners
      • Dividend Payments
      • Any retirement of common stock
  • Increases in debt or common stock are cash flow from owners or creditors
cash flow identity to sources and uses of cash
Cash Flow Identity to Sources and Uses of Cash
  • Once the components of the cash flow identity are calculated…
    • Convert the information into the Statement of Cash Flow or Sources and Uses of Cash
    • The change in the cash account is the “bottom line” of this statement
  • Three Categories
    • Operating Activities
    • Investing Activities
    • Financing Activities
estimating incremental cash flow
Estimating Incremental Cash Flow
  • Objective – Estimate future cash flow of a project (for decision making)
  • Only Incremental Cash Flow used in decision
    • Sunk Costs – Do not use
    • Erosion Costs – Must account for lost sales of old products when new product introduced
    • Working Capital – new projects require working capital, must include in cash flow
    • Capital Expenditures – Usually large up front cash flow out
    • Depreciation and cost recovery on divesting assets
capital spending and depreciation
Capital Spending and Depreciation
  • Capital Spending for a project is usually an up front cash outflow
  • It is expensed on the income statement over time via depreciation
    • Depreciation is not a cash flow
    • Deprecation impacts cash flow through reduction in taxes, a real cash flow
  • Different Types
    • Straight line depreciation
    • Modified Accelerated Cost Recovery System (MACRS)
capital spending and depreciation11
Capital Spending and Depreciation
  • Depreciation example for Cogswell Cola
    • Bottling Machine – Initial cost is $1,500,00
      • Include installation costs, another $150,000
      • Property class for MACRS is 7 years
    • Annual depreciation expense
      • Year 1 = $1,650,000 x 0.1429 = $235,785
      • Year 2 = $1.650,000 x 0.2449 = $404,085
      • Year 8 = $1,650,000 x 0.0445 = $73,425
  • Table 10.7 for all eight years
disposal of capital equipment
Disposal of Capital Equipment
  • When a capital asset is disposed of by a company it can result in cash flow
    • Fully depreciated assets, sale price minus taxes paid on gain on sale
    • When asset is not fully depreciated
      • Determine current “book value” of asset
      • Difference between sales price and book value is the gain or loss on disposal
      • Tax a gain and tax credit on a loss
      • Cash flow is sales price – tax or sales price + credit
  • Example 10.3 College Doughnuts Disposal
projected cash flow for project
Projected Cash Flow for Project
  • Putting all the elements together on incremental cash flow for decision making on a project
    • Initial Investment (typically capital spending and increases in working capital)
    • Annual operating cash flow
    • Disposal of equipment
    • Decrease in working capital at conclusion of project
  • Use Incremental Cash Flow with
    • NPV Model
    • IRR Model
  • Example Bottle Water Project – Table 10.12
problems
Problems
  • Problem 1 – Balance Sheet Accounts
  • Problem 3 – Operating Cash Flow
  • Problem 5 – Income Statement
  • Problem 6 – Cash Flow from Assets
  • Problem 7 – Cash Flow to Creditors
  • Problem 8 – Cash Flow to Owners
  • Problem 9 – Cash Flow Identity
  • Problem 11 – Erosion Costs
  • Problem 15 – Depreciation Costs