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CF. 473.32 12 Winter 2014. Questions. What cash flows should I consider? How does the market set r ? How should I set r ?. CF 1. at CF 1 n 1 = 0. at time 0. CF 1. at time 0 at the very beginning of the project when decision to go ahead made

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slide1

CF

473.32

12

Winter 2014

questions
Questions
  • What cash flows should I consider?
  • How does the market set r?
  • How should I set r?
slide3
CF1

at CF1n1= 0

  • at time 0
slide4
CF1
  • at time 0
    • at the very beginning of the project
      • when decision to go ahead made
        • any costs incurred to make decision ignored
    • when added all together
      • almost always < $0
slide5
CF1
  • at time 0
    • includes
      • capital cost
        • usually equipment
      • shipping, installation, training, etc.
        • everything needed to get it up & running
      • working capital
        • cash
      • flotation costs

start-up costs

slide6
CF1
  • at time 0
    • also includes
      • present value of Capital Cost Allowance
        • minus the CCA of salvage revenue
        • PVCCA tax shield
      • PV of getting working capital back
        • PVworking capital
slide8
CF1

start-up costs

weighted average flotation cost

fa

flotation costs
Flotation Costs
  • issuing new stocks or bonds isn’t free
    • weighted average flotation cost

debt

equity

2/1

1/1

1/2

2

1

.5

fd=2%

fe=5%

wd=.67

wd=.50

wd=.33

we=.33

we=.50

we=.67

flotation costs1
Flotation Costs
  • issuing new stocks or bonds isn’t free
    • weighted average flotation cost
      • use target weights
        • over the long term,

firm will issue securities in these percentages

flotation costs2
Flotation Costs
  • project
    • firm’s target D/E ratio is .6
    • flotation costs
      • 5% equity
      • 3% debt
slide14

you get the cash (working capital) back at end of project

what’s that refund worth to you today?

cca tax shield
CCA tax shield
  • tCCACCA tax shield rate
  • tc corporate tax rate
  • rdiscount rate
  • s salvage value
  • n number of periods in the project
productivity
Productivity
  • considering
    • new production system
      • initial cost $1 million
      • save $300,000/yr
        • in inventory & receivables management costs
      • last for 5 years
      • CCA tax shield rate of 20%
      • salvage value of $50,000
      • no impact on Net Working Capital
      • marginal tax rate is 40%
      • required return is 8%.
applications
Applications
  • cost-cutting proposals
  • replacing an asset
  • setting a bid price
  • comparing equipment with different lifespans
cost cutting proposal
CCA tax rate

20%

salvage

$0

tax rate

40%

discount rate

10%

Cost-Cutting Proposal
  • equip
    • $80,000
      • to buy & install
  • save
    • $35,000
      • pretax
  • lifespan
    • 5 years
  • NWC
    • $0
replacement
original machine

initial cost

$150,000

purchased

4 yrs ago

salvage today

$50,000

salvage in 6 yrs

$10,000

new machine

initial cost

$200,000

6-year life

salvage in 6 yrs

$30,000

cost savings

$75,000/year

net working capital

$0

Replacement?

CCA rate = 20%

required return = 15%

marginal tax rate = 44%

$150,000

PV

PV

-PV

only question: What will be different if we do project?

setting a bid price
required return

20%

5 trucks/year

for 4 years

truck platforms

$10,000 ea

facilities lease

$24,000/year

labor & material

$4,000/truck

new equipment

$60,000

salvage

$5,000

NWC

$40,000

CCA

20%

tax

43.5%

Setting a Bid Price