Financial Management II Lecture 09 Shama-e Zaheer Capital Budgeting: Estimating Cash Flows Initial Cash Outflow a) Cost of new

assets b) + Capitalized expenditures c) + (-) Increased (decreased) net working capital d) Net proceeds from sale of old asset(s) if replacement e) + (-) Taxes (savings) due to the sale of old asset(s) if replacement f) = Initial cash outflow Incremental Cash Flows a) Net incr. (decr.) in operating revenue less (plus) any net incr. (decr.) in operating expenses, excluding depreciation b) - (+) Net incr. (decr.) in tax depreciation c) = Net change in income before taxes d) - (+) Net incr. (decr.) in taxes e) = Net change in income after taxes f) - (+) Increased (decreased) level of net working capital g) + (-) Net incr. (decr.) in tax depreciation charges h) = Incremental net cash flow for period Terminal-Year Incremental Cash Flows a) Calculate the incremental net cash flow for the terminal period b) + (-) Salvage value (disposal/reclamation costs) of any sold or disposed assets c) - (+) Taxes (tax savings) due to asset sale or disposal of new assets d) + (-) Decreased (increased) level of net working capital e) = Terminal year incremental net cash flow

A) Adam Smith is considering automating his pen factory with the purchase of a $475,000 machine. Shipping and installation would cost $5,000. Smith has calculated that automation would result in savings of $45,000 a year due to reduced scrap and $65,000 a year due to reduced labor costs. The machine has a useful life of 4 years for depreciation purposes. The estimated salvage value of the machine at the end of four years is $120,000. The old machine is fully depreciated, but has a salvage value today of $100,000. The firm's marginal tax rate is 34 percent. a. What is the initial cash outflow at time period 0? b. What would be the relevant incremental cash inflows over the machine's useful life?

B) Basket Wonders (BW) is considering the purchase of a new basket weaving machine. The machine will cost $50,000 plus $20,000 for shipping and installation and will be depreciated over 4 years. NWC will rise by $5,000. Lisa Miller forecasts that revenues will increase by $110,000 for each of the next 4 years. The machine will then be sold (scrapped) for $10,000 at the end of the fourth year, when the project ends. Operating costs will rise by $70,000 for each of the next four years. BW is in the 40% tax bracket.

a. What is the initial cash outflow?

b. What are the interim incremental net cash flows for each year? c. What is the terminal year cash flow?

C) BugBusters of Antarctica, Inc. is considering replacing a machine with a new machine that has a four-year life. The purchase of this new machine has a cost of $700,000, shipping cost of $80,000, and an installation charge of $20,000. This machine will not require any additional working capital. The old machine can be salvaged for $75,000 currently. The old machine has four years useful life remaining with a depreciation expense of $20,000 for each of those years and was originally purchased six years ago for $200,000. The new machine will not generate additional revenues, but will decrease operating expenses by $90,000 for each year of the four-year project. The equipment has four years of operable life. The company is subject to a marginal tax rate of 40%. The salvage value at the end of the fourth year for the new machine is expected to be $50,000.

a. What is the initial cash outflow?

b. What are the interim incremental net cash flows for each year? c. What is the terminal year cash flow?