3 Learning Objectives 5 1. Understand how to use EXCEL Spreadsheet 6 (a) Develop proforma Income Statement Using Excel Spreadsheet 7 (b) Compute Net Project Cashflows, NPV, and IRR 8 (c) Develop problem-solving and critical thinking skills and make long-term investment decisions 10 11 1) Life Period of the Equipment = 4 years 8) Sales for first year (1) 12 2) New equipment cost $ (200,000) 9) Sales increase per year 13 3) Equipment ship & Install cost $ (35,000) 10) Operating cost (60% of Sales) 14 4) Related start up cost $ (5,000) (as a percent of sales in Year 1) 15 5) Inventory Increase $ 25,000 11) Depreciation (Straight Line)/YR 16 6) Accounts Payable Increase $ 5,000 12) Marginal Corporate Tax Rate (T) 17 7) Equip. salvage value before tax $ 15,000 13) Cost of Capital (Discount Rate) $ $ 200,000 5% (120,000) -60% (60,000) 21% 10% $ 18 20 21 ESTIMATING Initial Outlay (Cash Flow, CFO, T=0) CFO CF1 CF4 CFO CF2 CEP CE2 CF3 C FA 24 Year 25 Investments: 26 1) Equipment cost 27 2) Shipping and Install cost 28 3) Start up expenses 29 Total Basis Cost (1+2+3) 30 4) Net Working Capital Total Initial Outlay 31 33 Operations: 34 Revenue 35 Operating Cost 36 Depreciation 37 EBIT 38 Taxes 39 Net Income 40 41 Add back Depreciation Total Operating Cash Flow - $ 45 Terminal: 46 1) Change in net WC 47 2) Salvage value (after tax) 48 Total S - Salvage Value Before Tax (1-T) 20,000 XXXXX XXXXX S . S . S . $ . $ 52 NPV = IRR = Payback Q#1 Q#2 Would you accept the project based on NPV, IRR? Would you accept the project based on Payback rule if project cut-off is 3 years? Impact of 2017 Tax Cut Act on Net Income, Cash Flows and Capital Budgeting (Investment) Decisions Estimate NPV, IRR and Payback period of the project if equipment is fully depreciated in first year and tax rate equals to 21%. Would you accept or reject the project? As a CFO of the firm, which of the above two scenario (a) or (b) would you choose? Why? (a) (b) accept or reject the project? 2 (b) As a CFO of the firm, which of the above two scenario (a) or (b) would you choose? Why? 4 Q#3 How would you explain to your CEO what NPV means? 5 Q#4 What are advantages and disadvantages of using only Payback method? 6 Q#5 What are advantages and disadvantages of using NPV versus IRR? 7 Q#6 Explain the difference between independent projects and mutually exclusive projects. When you are confronted with Mutually Exclusive Projects and have coflicts with NPV and IRR results, which criterion would you use (NPV or IRR) and why? O oo