...Dividends, if cash, is shown in the financing section. | GENERAL rules for the Statement of Cash Flows (Indirect Method) Cash provided by op. activities: Net Income (from Income Statement) + Depreciation, amortization, and/or depletion (From Income Statement) + Decrease in CURRENT Asset accounts other than cash (calculate the difference between this period and last period from Balance Sheet) - Increase in CURRENT Asset accounts other than cash (calculate the difference between this period and last period from Balance Sheet) + Increase in CURRENT Liabilities accounts (calculate the difference between this period and last period from Balance Sheet) - Decrease in CURRENT Liabilities accounts (calculate the difference between this period and last period from Balance Sheet)+ Loss on Disposal of PPE/Fixed Assets used in normal operations (From Income St.)- Gain on Disposal of PPE/Fixed Assets used in operations (From Income Statement) = cash provided by op. activities Cash provided by investing activities: - Increase in PPE and LONG-TERM Assets if paid cash (calculate the difference between this period and last period from Balance Sheet) + Decrease in PPE and LONG-TERM Assets if received cash (calculate the difference between this period and last period from Balance Sheet) - Increase in Investments Assets if paid cash (calculate the difference between this period and last period from Balance Sheet) + Decrease in Investments Assets if received cash (calculate the...
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...GENERAL rules for the Statement of Cash Flows (Indirect Method) Cash provided by op. activities: Net Income (from Income Statement) + Depreciation, amortization, and/or depletion (From Income Statement) + Decrease in CURRENT Asset accounts other than cash (calculate the difference between this period and last period from Balance Sheet) - Increase in CURRENT Asset accounts other than cash (calculate the difference between this period and last period from Balance Sheet) + Increase in CURRENT Liabilities accounts (calculate the difference between this period and last period from Balance Sheet) - Decrease in CURRENT Liabilities accounts (calculate the difference between this period and last period from Balance Sheet) + Loss on Disposal of PPE/Fixed Assets used in normal operations (From Income St.) - Gain on Disposal of PPE/Fixed Assets used in operations (From Income Statement) = cash provided by op. activities Cash provided by investing activities: - Increase in PPE and LONG-TERM Assets if paid cash (calculate the difference between this period and last period from Balance Sheet) + Decrease in PPE and LONG-TERM Assets if received cash (calculate the difference between this period and last period from Balance Sheet) - Increase in Investments Assets if paid cash (calculate the difference between this period and last period from Balance Sheet) + Decrease in Investments Assets if received cash (calculate the difference between this period and last period from...
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...and which will fail. The capital markets will send the firm signals about how well it is doing. Net Present Value (NPV) The net present value is the difference between the market value of an investment and its cost. [pic] NPV is a measure of the amount of market value created by undertaking an investment project. The interest rate, r, will reflect the risk of the cash flows. Finding the market value of the investment 6. Use discounted cash flow valuation (calculate present values). 7. Compute the present values of future cash flows Net Present Value Rule (NPV): An investment should be accepted if the net present value is positive and rejected if the net present value is negative. Positive NPV projects create shareholder value. Using NPV The marketing department of your firm is considering whether to invest in a new product. The costs associated with introducing this new product and the expected cash flows over the next four years are listed below. (Assume these cash flows are 100% likely). The appropriate discount rate for these cash flows is 20% per year. Should the firm invest in this new product? Costs: ($ million) Promotion and advertising 100.00 Production & related costs 400.00 Other 100.00 Total Cost 600.00 |...
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...CHAPTER 13 - WEIGHING NET PRESENT VALUE AND OTHER CAPITAL BUDGETING CRITERIA Questions LG1 1. Is the set of cash flows depicted below normal or non-normal? Explain. |Time |0 |1 |2 |3 |4 |5 | |Cash Flow |-$100 |-$50 |$80 |$0 |$100 |$100 | They’re normal: there is only one change in cash flows from negative to positive. LG1 2. Derive an accept/reject rule for IRR similar to 13-8 that would make the correct decision on cash flows that are non-normal, but which always have one large positive cash flow at time zero followed by a series of negative cash flows: |Time |0 |1 |2 |3 |4 |5 | |Cash Flow Sign |+ |- |- |- |- |- | With one positive at the beginning and all future cash flows negative, this type of project would be worth more if rates were higher, implying that the NPV profile would be upward-sloping. So the appropriate accept/reject decision rule would look like Accept Project if IRR ≤ Cost of Capital Reject Project if IRR > Cost of Capital LG1 3. Is it possible for a company to initiate two products that target the same market and are not mutually exclusive? Sure, as long as the market has room for both products. LG2 4. Suppose that your company used “APV”, or “All-the-Present Value-Except-CF0”, to analyze capital budgeting projects. What would this rule’s benchmark value...
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...the timing of potential cash flows. • Drawing a timeline of the cash flows will help you visualize the financial problem. Copyright © 2011 Pearson Education. All rights reserved. Copyright © 2011 Pearson Education. All rights reserved. 4-2 4.1 The Timeline (cont’d) • Assume that you made a loan to a friend. You will be repaid in two payments, one at the end of each year over the next two years. 4.1 The Timeline (cont’d) • Differentiate between two types of cash flows – Inflows are positive cash flows. – Outflows are negative cash flows, which are indicated with a – (minus) sign. Copyright © 2011 Pearson Education. All rights reserved. 4-3 Copyright © 2011 Pearson Education. All rights reserved. 4-4 1 20/09/2011 4.1 The Timeline (cont’d) • Assume that you are lending $10,000 today and that the loan will be repaid in two annual $6,000 payments. Textbook Example 4.1 • The first cash flow at date 0 (today) is represented as a negative sum because it is an outflow. • Timelines can represent cash flows that take place at the end of any time period – a month, a week, a day, etc. Copyright © 2011 Pearson Education. All rights reserved. 4-5 Copyright © 2011 Pearson Education. All rights reserved. 4-6 Textbook Example 4.1 (cont’d) 4.2 Three Rules of Time Travel • Financial decisions often require combining cash flows or comparing values. Three rules govern these processes. Table 4.1 The Three Rules of Time Travel Copyright...
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...if they wish to continue receiving funds from shareholders to employ the best techniques available when analysing which investment opportunities will give the best return. There are two types of project appraisal techniques: non-discounted cash flows and discounted cash flows. The Net Present Value and internal rate of return, examples of discounted cash flows, are in use in many large corporations and regarded as more effective than the traditional techniques of payback and accounting rate of return. In this paper, I will examine the use of the Net Present Value, and the provisions it makes for specific cases, such as unequal lives and mutually exclusive projects. Then I will conclude with the technique that has been proved the best for investment appraisal through the analysis and comparison of project appraisal techniques. The Net Present Value (NPV) method is used by 75% of firms when deciding on investment projects. The reasons for its wide use is that firstly, the NPV rule takes into account the time value of money, meaning that it recognises that a pound today is worth more than a pound tomorrow as the pound today can be invested to start earning interest immediately. Secondly, NPV depends solely on the forecasted cash flows from the project and the opportunity cost of capital. And the final reason for its preference is because the present values are all measured in today’s pounds they have the property of additivity. This property is important as it helps managers...
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...Spring 2011, test 3, question 9, version 4, modified by adding IRR & NPV 1. The following table presents information on a potential project with conventional cash flows currently being evaluated by SDA. Which of the statements are true? Expected cash flows (number of years from today) | Cost of capital | 0 | 1 | 2 | 3 | 4 | | -60,000 | 28,000 | 18,000 | 35,000 | 9,000 | 14.0% | Statement 1: SDA would accept the project based on the project’s payback period and the payback rule if the payback threshold is 2.25 years Statement 2: SDA would accept the project based on the project’s discounted payback period and the discounted payback rule if the discounted payback threshold is 2.85 years Statement 3: SDA would accept the project based on the project’s NPV and the NPV rule Statement 4: SDA would accept the project based on the project’s IRR and the IRR rule Spring 2011, test 3, question 7, version 4 2. Karim’s Kabobs is evaluating a project that would last for 3 years. The project’s cost of capital is 10.0 percent, its NPV is $20,000, and the expected cash flows are presented in the table. What is X? Years from today | 0 | 1 | 2 | 3 | Expected cash flow (in $) | -65,000 | 50,000 | -20,000 | X | 3. Kiwi operates juice shops in New Zealand. The firm is evaluating the Auckland project, which would involve opening a new juice shop in Auckland. During year 2, Kiwi would have total revenue of $476,000 and total costs of $286,000 if it pursues the Auckland...
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...0195301501_158-192_ch7.qxd 11/3/05 12:47 PM Page 158 CHAPTER 7 INTRODUCTION TO CAPITAL BUDGETING 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 Overview 159 The NPV Rule for Judging Investments and Projects 159 The IRR Rule for Judging Investments 161 NPV or IRR, Which to Use? 162 The “Yes–No” Criterion: When Do IRR and NPV Give the Same Answer? 163 Do NPV and IRR Produce the Same Project Rankings? 164 Capital Budgeting Principle: Ignore Sunk Costs and Consider Only Marginal Cash Flows 168 Capital Budgeting Principle: Don’t Forget the Effects of Taxes—Sally and Dave’s Condo Investment 169 Capital Budgeting and Salvage Values 176 Capital Budgeting Principle: Don’t Forget the Cost of Foregone Opportunities 180 In-House Copying or Outsourcing? A Mini-case Illustrating Foregone Opportunity Costs 181 Accelerated Depreciation 184 Conclusion 185 Exercises 186 158 0195301501_158-192_ch7.qxd 11/3/05 12:47 PM Page 159 CHAPTER 7 Introduction to Capital Budgeting 159 OVERVIEW Capital budgeting is finance terminology for the process of deciding whether or not to undertake an investment project. There are two standard concepts used in capital budgeting: net present value (NPV) and internal rate of return (IRR). Both of these concepts were introduced in Chapter 5; in this chapter we discuss their application to capital budgeting. Here are some of the topics covered: • Should you undertake a specific project? We call this the “yes–no” decision, and we show how both NPV...
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...METHODS OF EVALUATING CAPITAL INVESTMENTS Non-discounted cash flow methods * Payback period * Payback reciprocal * Payback bail-out period * Accounting rate of return Discounted cash flow methods * Net present value * Present value index (profitability index) * Annualized net present value or Equivalent annual annuity * Present value/discounted payback * Internal rate of return * Modified internal rate of return Methods that consider risk * Breakeven Cash Inflow * Risk-Adjusted Discount Rates * Certainty Equivalents * Simulation * Sensitivity and Scenario Analysis * Probability Trees I. Non-discounted cash flow techniques: A. Payback period (payoff/payout period) – measures the length of time required to recover the initial investment Decision rule: Accept if payback < required maximum payback Reject if payback > required maximum payback 1. Even cash flows Payback Period = Net Investment Annual CFAT 2. Uneven cash flows Payback Period = point where the cumulative cash flows equal the net investment Advantages: 1. easy to compute and understand 2. used to measure degree of risk associated with a project 3. generally, the longer the payback period, the higher the risk 4. used to select projects...
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...Assignment ACCT 311 The Cash Flow Statement: Problems with the Current Rules This article is about the cash flow statement and its problems with the current rules. It was written by Neil S. Weiss and James G.S. Yang. The cash flow statement has been used to give information about a company’s performance, as well as well as its major activities during the year. However, some of the rules for preparation make the cash flow statement less useful than it should be. Based on the article, the authors listed weaknesses of the statement of cash flow which are divided in five sections. 1) differences between commercial and industrial companies versus financial institutions; 2) problems with operating activities; 3) problems with investing activities; 4) problems with financing activities; and 5) the role of free cash flow. Due to these weaknesses, the authors offer potential solutions to these problems that could improve the cash flow statement. Regarding the case of financial institutions, the identification of the core operating activities is important, because they differ markedly from nonfinancial companies in this respect. Considering commercial banking institutions, where the core operations can be divided between on–balance sheet activities and off–balance sheet activities. The off–balance sheet activities consist primarily of fee-based activities for services rendered that do not create an asset or a liability. These create no problem for the cash flow presentation because they...
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...In financial accounting, a cash flow statement, also known as statement of cash flows or funds flow statement,[1] is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and cash out of the business. The statement captures both the current operating results and the accompanying changes in the balance sheet.[1] As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7), is the International Accounting Standard that deals with cash flow statements. People and groups interested in cash flow statements include: * Accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses * Potential lenders or creditors, who want a clear picture of a company's ability to repay * Potential investors, who need to judge whether the company is financially sound * Potential employees or contractors, who need to know whether the company will be able to afford compensation * Shareholders of the business. Contents [hide] * 1 Purpose * 2 History & variations * 3 Cash flow activities o 3.1 Operating activities o 3.2 Investing...
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...investment decision depends upon the decision rule that is applied under circumstances. However, the decision rule itself considers following inputs. Cash flows, Project Life, and Discounting Factor The effectiveness of the decision rule depends on how these three factors have been properly assessed. Estimation of cash flows requires immense understanding of the project before it is implemented; particularly macro and micro view of the economy, polity and the company. Project life is very important; otherwise it will change the entire perspective of the project. So, great care is required to be observed for estimating the project life. Cost of capital is being considered as discounting factor which has undergone a change over the years. Cost of capital has different connotations in different economic philosophies. Hence, determination of cost of capital would carry greatest impact on the investment evaluation. A number of capital budgeting techniques are used in practice. They may be grouped in the following two categories: - I. Capital budgeting techniques under certainty; and II. Capital budgeting techniques under uncertainty 2. Capital budgeting techniques under certainty Capital budgeting techniques (Investment appraisal criteria) under certainty can also be divided into following two groups: 2.1 Non-Discounted Cash Flow Criteria: - (a) Pay Back Period (PBP) (b) Return On Investment (ROI) 2.2 Discounted Cash Flow Criteria: - (a) Net Present Value (NPV) ...
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...» which distribution channel » should I test market a product Copyright © Michael R. Roberts 2 1 1 Discounted Cash Flows (DCF) A Tool for Rational Decision Making What can be an object of capital budgeting procedures? » There must be a choice - choose a base case and an alternative. (Do nothing/status quo) Identify incremental cash flows from project » Treat as incremental cash flows to shareholder (marginal impact) Calculate the value of the project. » Taking into account timing and risk (t and re) » Aggregate cash flows into one single number Show that doing all and only projects which have positive net present value maximizes the value of the firm. Copyright © Michael R. Roberts 3 Estimating Relevant Cash Flows The relevant cash flows for evaluating a new investment project are the incremental cash flows contributed by the project. Incremental Cash Flows = Firm’s CFs with Project Firm’s CFs without Project Only Incremental Cash Flows are Relevant. But consider, » » » » » » » » Side effects of the project Investment in working capital. Forget about sunk costs. Include all opportunity costs Allocated overhead expenses. Impact on taxes (depreciation & expense) Separate investment from financing decisions Cash flow uncertainty, use expected values Copyright © Michael R. Roberts 4 2 2 Estimating Cash Flows Example A new machine costs $60,000 » » » » installation costs of $2,000. generates revenues of $155,000 and expenses of...
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...Estimates of future costs and benefits over the project’s life. 3 • Every business would like to do everything • But it all costs • Capital expenditure on new projects or purchases (fixed assets) needs to be planned • Capital is always rationed Scenario: • Your business wishes to expand its product line • It is considering Products A and B but it can only afford to do one. • How does it decide? What main factors affect the investment decision • How much will it cost ? Investment appraisal methods used in practice • How much will I get back ? • When will I get the income ? • 4 main techniques available ranging from simple to moderately complex MULTIPLE APPRAISAL METHODS: Non‐discounted cash flow techniques: 1. Payback period (PBP) 2. Accounting rate of return (ARR/ROCE/ROI) Discounted cash flow techniques(DCF): 3. Net Present Value (NPV) 4. Internal Rate of Return (IRR) 6 1 MBA7001 Accounting for Decision-Makers Week 6 Lecture – Capital Investment Appraisal Objectives (1)...
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...INVESTMENT DECISION AND CASH FLOWS A positive net present value (NPV) is a direct estimate of value creation for shareholders and is an operational way of carrying through on the strategy of trying to maximize shareholder wealth. To calculate NPV, however we need to estimate the cash costs and benefits of any decision at hand. In this note we discuss the evaluation of investment proposals. Cash Flows: Basic Concepts The cash flows that we will use in our analysis are incremental after-tax cash flows. The incremental-cash-flow rule is that the cash flows relevant in analyzing an investment opportunity are those after-tax cash flows and only those after-tax cash flows directly attributable to the investment. The words incremental, after-tax and cash are critical. The term cash calls attention to the fact that we are interested in cash flow and not accounting profits. Ultimately, financial transactions must be carried out with cash, not profits, so we look to cash as the source of value. As we will see, we are interested in all cash flows affected by a decision under evaluation, no matter how those cash flows are classified for accounting purposes. The term after-tax emphasizes that we are able to keep the cash only after payment of taxes. The word incremental is important because in deciding whether to do something, or whether to pick alternative A or alternative B, differences in outcomes are of interest. What changes as a result of the decision? If a firm replaces a piece of...
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