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 capital budgeting?

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3 4 Investment Outlays at Time = 0 CAPEX = Building and Equipment ANOWC = Additional net operating working -$900 capital needed -100 Operating Cash Flows over the Project's Life (Time = 1- 4) Unit sales Sales price Variable cost per unit Sales revenues = Units x Price Variable costs = Units * Cost/unit Fixed operating costs except depr'n Depreciation: Accelerated from table below Total operating costs EBIT (or operating income) Taxes on operating income EBIT (1– T) = After-tax project operating income Add back depreciation EBIT (1– T) + Depreciation 2,450 $2.00 2,685 2,600 2,525 $2.00 $2.00 $2.00 $1.018 $1.078 $1.046 $1.221 $5,200 2,803 $5,050 2,640 $4,900 2,992 2,000 $5,370 2,735 2,000 2,000 2,000 297 405 135 63 $5,032 $5,208 $4,775 $5,055 $338 -$8 $275 -$155 40% 135 -3 110 -62 $203 -$5 $165 -$93 297 405 135 63 $500 $400 $300 -$30 Terminal Cash Flows at Time = 4 Salvage value (taxed as ordinary income) Tax on salvage value = 0.4 x (SV – BV of equipment at t = 4) 50 20 After-tax salvage value ANOWC = Recovery of net operating working capital Project free cash flows = EBIT(1 – T) + DEP 30 100 - CAPEX – ANOWC -$1,000 $500 $400 $300 $100 Depreciation Accelerated 1 2 3 4 Cost: $900 Rate 33% 45% 15% 7% Depreciation $297 $405 $135 $63 Alternative depreciation Straight line 2 3. 4 Cost: $900 Rate 25% 25% 25% 25% $225 Depreciation $225 $225 $225 Project Evaluation @ WACC = 10% Accelerated Formulas Straight line NPV IRR $78.82 =NPV(D43,F35:135)+E35 =IRR(E35:135) $64.44 14.489% 13.437% MIRR 12.106% =MIRR(E35:135,D43,D43) =G12+(-E35–F35-G35)/H35 11.731% Payback 2.60 2.33