Chapter 8 Estimating Incremental Cash Flows u Relevant

Chapter 8 -- Estimating Incremental Cash Flows u. Relevant Cash Flow u. A cash flow that is caused by a course of action or project u. Irrelevant u. A Cash Flow that does not change as a result of a course of action

Relevant Cash Flows u. Indirect cost -- Relationship may be fuzzy but it should be estimated u. Indirect benefits -- Need to be estimated u. Claims by supplier of capital -- Cost is usually taken care of in the discount rate u. Interest Expense -- Cost is usually taken care of in the discount rate u. Opportunity cost -- Next best course of action not taken -- could be very important

Irrelevant Cash Flows u Sunk cost: u. These are past costs and are therefore irrelevant u. Make the best use of the capacity put in place by past decisions u Pure joint cost: u. Are common costs that do not change as a result of an action and are therefore irrelevant

11 Steps to Estimating Cash Flows From a Project u. Four groups of steps: u. Estimating the Income Statement u. Estimating the Balance Sheet u. Rolling the Income Statement and Balance Sheet into a Cash Flow Statement u. Making the Decision

Estimating the Income Statement u. Estimate the relevant revenues and expenses u. Assemble into an income statement u. Remember -- Accrual accounting is not the same as cash basis accounting

Estimating the Balance Sheet u. Determine the balance sheet accounts that are impacted u. Estimate the initial size of the investment u. Determine the size and growth during operations

Rolling the Income Statement and Balance Sheet into a Cash Flow Statement u. Calculate depreciation u. Estimate the life of the project u. Determine terminal values for fixed assets u. Determine disposal values for working capital u. Construct the cash flow statement

Making the Decision u. Calculate the present value u. Make the decision

Estimating Balance Sheet Accounts u This Receivable: is when you extend credit to your customers u typically occur in year 0 -- because they are closer to the beginning of the year than end u typically increase with increase in sales u credit losses are fully deductible u often liquidated at a loss

Estimating Balance Sheet Accounts u. Inventory: utypically occur in year 0 utypically increase with increase in sales uinventory losses are fully deductible uoften liquidated at a loss

Estimating Balance Sheet Accounts u. Cash Balances: utypically occur in year 0 utypically increase with increase in sales uliquidated at full value

Estimating Balance Sheet Accounts u usually Payable: associated the purchase of inventory u typically occur in year 0 u typically increase with increase in sales u are a source of cash (positive number) increases in liabilities are source of cash u often liquidated at full value

Estimating Balance Sheet Accounts u. Accrued Expenses: uassociated with employees and others utypically occur in year 0 utypically increase with increase in sales uoften liquidated at full value

Estimating & Depreciating Land – A Balance Sheet Account u. Land: ucannot be depreciated utypically occur in year 0 uonly increases with additional acquisitions umay be 1250 gain or loss on disposal udisposal gains and losses are fully taxable

Estimating & Depreciating Buildings -- A Balance Sheet Account u Buildings: u either classified as residential or commercial u residential depreciated over 27. 5 years u commercial depreciated over 39 years u must use mid-month convention u typically occur in year 0 u often liquidated with a 1250 gain or loss u disposal gains and losses are fully taxable

Estimating & Depreciating Equipment -- A Balance Sheet Account u. Equipment: uare grouped into one of 6 asset classifications -- 3, 5, 7, 10, 15, 20 year lives ufind the class, use the table rates utypically occur in year 0 uoften liquidated with a 1245 gain or loss udisposal gains and losses are fully taxable

Calculation of disposition stage gain or loss and cash flow u original purchase price - depreciation taken = remaining basis u Selling price - remaining basis = taxable gain or loss u taxable gain or loss * tax rate = taxes owed or tax refund u Cash selling price - taxes owed or + tax refund = disposition stage cash flow

Forecasting Sales utrend analysis ustudy of potential purchasers uderived demand uother methods

Forecasting Operating Cost, and Working Capital u. Forecasting Cost: uengineering analysis uregression analysis -- fixed and variable u. Forecasting uregression Working Capital: analysis -- from past relationships