Operating cash flows rather than accounting income are listed in Table 12-1. Why do we focus on cash flows as opposed to net income in capitalbudgeting?

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3. 4 Investment Outiays at Time =0 Equipment -$900 Net WC -100 Net Cash Flows Over the Project's Life Unit sales 537 520 505 490 S10.00 $5.092 $5,370 2,735 2,000 $10.00 $5.391 $5,200 2,803 2,000 $10.00 $5.228 $5,050 2,640 2,000 Sales price Variable cost per unit Sales revenues = Units x Price $10.00 $6.106 $4,900 2,992 2,000 Variable costs = Units x Cost/unit Fixed operating costs except depr'n Depreciation: Accelerated from table below Total operating costs EBIT (or operating income) Taxes on operating income After-tax project operating income Add back depreciation 297 405 135 63 $5,208 -$8 $5,032 $338 $4,775 $275 $5,055 -$155 40% 135 -3 110 -62 $203 -$5 $165 -%2493 297 135 405 63 Salvage value (taxed as ordinary income) Tax on salvage value (SV is taxed at 40%) Recovery of net working capital Project net cash flows (Time Line) 50 -20 100 $100 -$1,000 $500 $400 $300 Depreciation Accelerated Rate Cost: $900 33% 45% $405 15% $135 7% $63 Depreciation $297 Straight line Alternative depreciation Cost: Rate $900 25% $225 25% $225 25% $225 25% $225 Depreciation Project Evaluation a WACC = 10% Formulas Accelerated Straight line =NPV(D29 F22:122)+E22 =IRR(E22:122) =MIRR(E22:122,D29,D29) =G2+(-E22-F22-G22)/H22 NPV IRR $78.82 14.489% $64.44 13.437% MIRR 12.106% 11.731% Payback 2.60 1. Accelerated depreciation rates are set by Congress. We show the approximate rates for a 4-year asset in 2008. Companies also have the option of using straight-line depreciation. Under IRS rules, salvage value is not deducted when establishing the depreciable basis. However, if a salvage payment is received, it is called a recapture of depreciation 2.33 and is taxed at the 40% rate. 2. If the firm owned assets that would be used for the project but would be sold if the project is not accepted, the after-tax value of those assets would be shown as an "opportunity cost"in the "Investment Outlays" section. 3. If this project would reduce sales and cash flows from one of the firm's other divisions, then the after-tax cannibalization effect, or "externality" would be deducted from the net cash flows shown on Row 22. 4. If the firm had previousiy incurred costs associated with this project, but those costs could not be recovered regardless of whether this project is accepted, then they are "sunk costs"and should not enter the analysis.