Kế toán, kiểm toán - Chapter 13: Capital budgeting: Estimating cash flows and analyzing risk

CHAPTER 13Capital Budgeting: Estimating Cash Flows and Analyzing Risk1TopicsEstimating cash flows:Relevant cash flowsWorking capital treatmentInflationRisk Analysis: Sensitivity Analysis, Scenario Analysis, and Simulation Analysis2Proposed Project Data$200,000 cost + $10,000 shipping + $30,000 installation.Economic life = 4 years.Salvage value = $25,000.MACRS 3-year class.Continued3Project Data (Continued)Annual unit sales = 1,250.Unit sales price = $200.Unit costs = $100.Net operating working capital:NOWCt = 12%(Salest+1)Tax rate = 40%.Project cost of capital = 10%.4Incremental Cash Flow for a ProjectProject’s incremental cash flow is:Corporate cash flow with the project Minus Corporate cash flow without the project.5Treatment of Financing CostsShould you subtract interest expense or dividends when calculating CF? NO.We discount project cash flows with a cost of capital that is the rate of return required by all investors (not just debtholders or stockholders), and so we should discount the total amount of cash flow available to all investors. They are part of the costs of capital. If we subtracted them from cash flows, we would be double counting capital costs.6Sunk CostsSuppose $100,000 had been spent last year to improve the production line site. Should this cost be included in the analysis?NO. This is a sunk cost. Focus on incremental investment and operating cash flows.7Incremental CostsSuppose the plant space could be leased out for $25,000 a year. Would this affect the analysis?Yes. Accepting the project means we will not receive the $25,000. This is an opportunity cost and it should be charged to the project.A.T. opportunity cost = $25,000 (1 - T) = $15,000 annual cost.8ExternalitiesIf the new product line would decrease sales of the firm’s other products by $50,000 per year, would this affect the analysis? Yes. The effects on the other projects’ CFs are “externalities”.Net CF loss per year on other lines would be a cost to this project.Externalities will be positive if new projects are complements to existing assets, negative if substitutes.9What is the depreciation basis?Basis = Cost + Shipping + Installation $240,00010Annual Depreciation Expense (000s)Year% X(Initial Basis)= Depr.10.33$240$79.220.45108.030.1536.040.0716.811Annual Sales and CostsYear 1Year 2Year 3Year 4Units1250125012501250Unit Price$200$206$212.18$218.55Unit Cost$100$103$106.09$109.27Sales$250,000$257,500$265,225$273,188Costs$125,000$128,750$132,613$136,58812Why is it important to include inflation when estimating cash flows?Nominal r > real r. The cost of capital, r, includes a premium for inflation.Nominal CF > real CF. This is because nominal cash flows incorporate inflation.If you discount real CF with the higher nominal r, then your NPV estimate is too low. Continued13Inflation (Continued)Nominal CF should be discounted with nominal r, and real CF should be discounted with real r.It is more realistic to find the nominal CF (i.e., increase cash flow estimates with inflation) than it is to reduce the nominal r to a real r.14Operating Cash Flows (Years 1 and 2)Year 1Year 2Sales$250,000 $257,500 Costs$125,000 $128,750 Depr.$79,200 $108,000 EBIT$45,800 $20,750 Taxes (40%)$18,320 $8,300 NOPAT$27,480 $12,450 + Depr.$79,200 $108,000 Net Op. CF$106,680 $120,450 15Operating Cash Flows (Years 3 and 4)Year 3 Year 4Sales $265,225$273,188Costs $132,613$136,588Depr. $36,000$16,800EBIT $96,612$119,800Taxes (40%)$38,645$47,920NOPAT $57,967$71,880+ Depr. $36,000$16,800Net Op. CF $93,967$88,68016Cash Flows due to Investments in Net Operating Working Capital (NOWC)SalesNOWC(% of sales)CF Due toInvestment in NOWCYear 0$30,000-$30,000Year 1$250,000$30,900-$900Year 2$257,500 $31,827-$927Year 3$265,225$32,783-$956Year 4$273,188$0$32,78317Salvage Cash Flow at t = 4 (000s)Salvage Value$25Book Value 0Gain or loss$25Tax on SV 10Net Terminal CF$1518What if you terminate a project before the asset is fully depreciated?Basis = Original basis - Accum. deprec.Taxes are based on difference between sales price and tax basis.Cash flow from sale = Sale proceeds- taxes paid.19Example: If Sold After 3 Years for $25 ($ thousands)Original basis = $240.After 3 years, basis = $16.8 remaining.Sales price = $25.Gain or loss = $25 - $16.8 = $8.2.Tax on sale = 0.4($8.2) = $3.28.Cash flow = $25 - $3.28 = $21.72.20Example: If Sold After 3 Years for $10 ($ thousands)Original basis = $240.After 3 years, basis = $16.8 remaining.Sales price = $10.Gain or loss = $10 - $16.8 = -$6.8.Tax on sale = 0.4(-$6.8) = -$2.72.Cash flow = $10 – (-$2.72) = $12.72.Sale at a loss provides tax credit, so cash flow is larger than sales price!21Net Cash Flows for Years 1-3Year 0Year 1Year 2Init. Cost-$240,00000Op. CF0$106,680$120,450NOWC CF-$30,000-$900 -$927Salvage CF000Net CF-$270,000$105,780 $119,52322Net Cash Flows for Years 4-5Year 3Year 4Init. Cost00Op. CF$93,967$88,680NOWC CF-$956$32,783Salvage CF0$15,000Net CF$93,011$136,46323Enter CFs in CFLO register and I = 10. NPV = $88,030. IRR = 23.9%.01234(270,000)105,780119,52393,011136,463Project Net CFs on a Time Line24(270,000)MIRR = ?01234(270,000)105,780119,52393,011136,463 102,312 144,623 140,793 524,191What is the project’s MIRR? ($ in thousands)25Calculator SolutionEnter positive CFs in CFLO. Enter I = 10. Solve for NPV = $358,029.581.Now use TVM keys: PV = -358,029.581, N = 4, I/YR = 10; PMT = 0; Solve for FV = 524,191. (This is TV of inflows)Use TVM keys: N = 4; FV = 524,191; PV = -270,000; PMT= 0; Solve for I/YR = 18.0.MIRR = 18.0%.26Cumulative:Payback = 2 + 44/93 = 2.5 years.01234(270)*(270)106(164)120(44)9349136185What is the project’s payback? ($ thousands)27What does “risk” mean in capital budgeting?Uncertainty about a project’s future profitability.Measured by σNPV, σIRR, beta.Will taking on the project increase the firm’s and stockholders’ risk?28Is risk analysis based on historical data or subjective judgment?Can sometimes use historical data, but generally cannot.So risk analysis in capital budgeting is usually based on subjective judgments.29What three types of risk are relevant in capital budgeting?Stand-alone riskCorporate riskMarket (or beta) risk30Stand-Alone RiskThe project’s risk if it were the firm’s only asset and there were no shareholders.Ignores both firm and shareholder diversification. Measured by the σ or CV of NPV, IRR, or MIRR.310 E(NPV)Flatter distribution,larger , largerstand-alone risk.NPVProbability Density32Corporate RiskReflects the project’s effect on corporate earnings stability.Considers firm’s other assets (diversification within firm).Depends on project’s σ, and its correlation, ρ, with returns on firm’s other assets.Measured by the project’s corporate beta.33Profitability0YearsProject XTotal FirmRest of FirmProject X is negatively correlated to firm’s other assets, so has big diversification benefits. If r = 1.0, no diversification benefits. If r 0 = 97%.51Interpreting the ResultsInputs are consistent with specified distributions.Units: Mean = 1260, St. Dev. = 201.Price: Min = $163, Mean = $202, Max = $248.Mean NPV = $95,914. Low probability of negative NPV (100% - 97% = 3%).52Histogram of Results53What are the advantages of simulation analysis?Reflects the probability distributions of each input.Shows range of NPVs, the expected NPV, σNPV, and CVNPV.Gives an intuitive graph of the risk situation.54What are the disadvantages of simulation?Difficult to specify probability distributions and correlations.If inputs are bad, output will be bad:“Garbage in, garbage out.” (More...)55Sensitivity, scenario, and simulation analyses do not provide a decision rule. They do not indicate whether a project’s expected return is sufficient to compensate for its risk.Sensitivity, scenario, and simulation analyses all ignore diversification. Thus they measure only stand-alone risk, which may not be the most relevant risk in capital budgeting.56If the firm’s average project has a CV of 0.2 to 0.4, is this a high-risk project? What type of risk is being measured?CV from scenarios = 0.74, CV from simulation = 0.62. Both are > 0.4, this project has high risk.CV measures a project’s stand-alone risk.High stand-alone risk usually indicates high corporate and market risks.57With a 3% risk adjustment, should our project be accepted?Project r = 10% + 3% = 13%.That’s 30% above base r.NPV = $65,371.Project remains acceptable after accounting for differential (higher) risk.58Should subjective risk factors be considered?Yes. A numerical analysis may not capture all of the risk factors inherent in the project.For example, if the project has the potential for bringing on harmful lawsuits, then it might be riskier than a standard analysis would indicate.59What is a real option? Real options exist when managers can influence the size and risk of a project’s cash flows by taking different actions during the project’s life in response to changing market conditions.Alert managers always look for real options in projects.Smarter managers try to create real options.60What are some types of real options?Investment timing optionsGrowth options Expansion of existing product lineNew productsNew geographic markets61Types of real options (Continued)Abandonment optionsContractionTemporary suspensionFlexibility options62