1、8-1nEstimating cash flows:lRelevant cash flowslWorking capital treatmentlInflationnRisk Analysis:Sensitivity Analysis,Scenario Analysis,and Simulation AnalysisCHAPTER 8Cash Flow Estimation and Risk Analysis8-2nCost:$200,000+$10,000 shipping+$30,000 installation.nDepreciable cost$240,000.nEconomic li
2、fe=4 years.nSalvage value=$25,000.nMACRS 3-year class.Proposed Project8-3nAnnual unit sales=1,250.nUnit sales price=$200.nUnit costs=$100.nNet operating working capital(NOWC)=12%of sales.nTax rate=40%.nProject cost of capital=10%.8-4Incremental Cash Flow for a ProjectnProjects incremental cash flow
3、is:lCorporate cash flow with the projectMinus lCorporate cash flow without the project.8-5n 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 avai
4、lable to all investors.n They are part of the costs of capital.If we subtracted them from cash flows,we would be double counting capital costs.Should you subtract interest expense or dividends when calculating CF?8-6nNO.This is a sunk cost.Focus on incremental investment and operating cash flows.Sup
5、pose$100,000 had been spent last year to improve the production line site.Should this cost be included in the analysis?8-7nYes.Accepting the project means we will not receive the$25,000.This is an opportunity cost and it should be charged to the project.nA.T.opportunity cost=$25,000(1-T)=$15,000 ann
6、ual cost.Suppose the plant space could be leased out for$25,000 a year.Would this affect the analysis?8-8nYes.The effects on the other projects CFs are“externalities”.nNet CF loss per year on other lines would be a cost to this project.nExternalities will be positive if new projects are complements
7、to existing assets,negative if substitutes.If the new product line would decrease sales of the firms other products by$50,000 per year,would this affect the analysis?8-9Basis=Cost +Shipping +Installation$240,000What is the depreciation basis?8-10Year1234%0.330.450.150.07Depr.$79.2 108.0 36.0 17.8x B
8、asis =Annual Depreciation Expense(000s)$2408-11Annual 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$136,5888-12Why is it important to include inflation when
9、 estimating cash flows?nNominal r real r.The cost of capital,r,includes a premium for inflation.nNominal CF real CF.This is because nominal cash flows incorporate inflation.nIf you discount real CF with the higher nominal r,then your NPV estimate is too low.Continued8-13Inflation(Continued)nNominal
10、CF should be discounted with nominal r,and real CF should be discounted with real r.nIt 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.8-14Operating Cash Flows(Years 1 and 2)Year 1Year 2Sales$250,000$257,500Cos
11、ts$125,000$128,750Depr.$79,200$108,000EBIT$45,800$20,750Taxes(40%)$18,320$8,300NOPAT$27,480$12,450+Depr.$79,200$108,000Net Op.CF$106,680$120,4508-15Operating Cash Flows(Years 3 and 4)Year 3Year 4Sales$265,225$273,188Costs$132,613$136,588Depr.$36,000$16,800EBIT$96,612$119,800Taxes(40%)$38,645$47,920N
12、OPAT$57,967$71,880+Depr.$36,000$16,800Net Op.CF$93,967$88,6808-16Cash Flows due to Investments in Net Operating Working Capital(NOWC)NOWC Sales (%of sales)CFYear 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$32,7838-17Salvage Cash Flow a
13、t t=4(000s)Salvage valueTax on SVNet terminal CF$25(10)$35 8-18What if you terminate a project before the asset is fully depreciated?Cash flow from sale=Sale proceeds-taxes paid.Taxes are based on difference between sales price and tax basis,where:Basis=Original basis-Accum.deprec.8-19nOriginal basi
14、s=$240.nAfter 3 years=$16.8 remaining.nSales price=$25.nTax on sale=0.4($25-$16.8)=$3.28.nCash flow=$25-$3.28=$21.72.Example:If Sold After 3 Years(000s)8-20Net 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$10
15、5,780$119,5238-21Net Cash Flows for Years 4-5Year 3Year 4Init.Cost00Op CF$93,967$88,680NOWC CF-$956$32,783Salvage CF0$15,000Net CF$93,011$136,4638-22Project Net CFs on a Time LineEnter CFs in CFLO register and I=10.NPV =$88,030.IRR =23.9%.01234(270,000)105,780119,52393,011136,4638-23What is the proj
16、ects MIRR?(000s)(270,000)MIRR=?01234(270,000)105,780119,52393,011136,463102,312144,623140,793524,1918-241.Enter positive CFs in CFLO:I=10;Solve for NPV=$358,029.581.2.Use TVM keys:PV=-358,029.581,N=4,I=10;PMT=0;Solve for FV=524,191.(TV of inflows)3.Use TVM keys:N=4;FV=524,191;PV=-270,000;PMT=0;Solve
17、 for I=18.0.MIRR=18.0%.Calculator Solution8-25What is the projects payback?(000s)Cumulative:Payback=2+44/93=2.5 years.01234(270)*(270)106(164)120(44)93491361858-26What does“risk”mean in capital budgeting?nUncertainty about a projects future profitability.nMeasured by NPV,IRR,beta.nWill taking on the
18、 project increase the firms and stockholders risk?8-27Is risk analysis based on historical data or subjective judgment?nCan sometimes use historical data,but generally cannot.nSo risk analysis in capital budgeting is usually based on subjective judgments.8-28What three types of risk are relevant in
19、capital budgeting?nStand-alone risknCorporate risknMarket(or beta)risk8-29How is each type of risk measured,and how do they relate to one another?1.Stand-Alone Risk:nThe projects risk if it were the firms only asset and there were no shareholders.nIgnores both firm and shareholder diversification.nM
20、easured by the or CV of NPV,IRR,or MIRR.8-300E(NPV)Probability DensityFlatter distribution,larger ,largerstand-alone risk.Such graphics are increasingly usedby corporations.NPV8-312.Corporate Risk:nReflects the projects effect on corporate earnings stability.nConsiders firms other assets(diversifica
21、tion within firm).nDepends on:lprojects ,andlits correlation,r r,with returns on firms other assets.nMeasured by the projects corporate beta.8-32Profitability0YearsProject XTotal FirmRest of Firm1.Project X is negatively correlated to firms other assets.2.If r r 097%8-50Interpreting the ResultsnInpu
22、ts are consistent with specificied distributions.lUnits:Mean=1260,St.Dev.=201.lPrice:Min=$163,Mean=$202,Max=$248.nMean NPV=$95,914.Low probability of negative NPV(100%-97%=3%).8-51Histogram of Results-$60,000$45,000$150,000$255,000$360,000NPV($)Probability8-52What are the advantages of simulation an
23、alysis?nReflects the probability distributions of each input.nShows range of NPVs,the expected NPV,NPV,and CVNPV.nGives an intuitive graph of the risk situation.8-53What are the disadvantages of simulation?nDifficult to specify probability distributions and correlations.nIf inputs are bad,output wil
24、l be bad:“Garbage in,garbage out.”(More.)8-54nSensitivity,scenario,and simulation analyses do not provide a decision rule.They do not indicate whether a projects expected return is sufficient to compensate for its risk.nSensitivity,scenario,and simulation analyses all ignore diversification.Thus the
25、y measure only stand-alone risk,which may not be the most relevant risk in capital budgeting.8-55If the firms average project has a CV of 0.2 to 0.4,is this a high-risk project?What type of risk is being measured?nCV from scenarios=0.74,CV from simulation=0.62.Both are 0.4,this project has high risk
26、.nCV measures a projects stand-alone risk.nHigh stand-alone risk usually indicates high corporate and market risks.8-56With a 3%risk adjustment,should our project be accepted?n Project r=10%+3%=13%.n Thats 30%above base r.n NPV=$65,371.n Project remains acceptable after accounting for differential(higher)risk.8-57Should subjective risk factors be considered?nYes.A numerical analysis may not capture all of the risk factors inherent in the project.nFor example,if the project has the potential for bringing on harmful lawsuits,then it might be riskier than a standard analysis would indicate.
