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A B C D

1 TWO PROJECTS
2 Discount rate 12%
3
4 Year Project A Project B
5 0 -1000 -800
6 1 500 420
7 2 500 420
8 3 500 420
9 4 500 420
10 5 500 420
11
12 NPV 802.39 714.01 #VALUE!
A B C D
1 TWO PROJECTS
2 Discount rate 12%
3
4 Year Project A Project B
5 0 -1000 -800
6 1 500 420
7 2 500 420
8 3 500 420
9 4 500 420
10 5 500 420
11
12 IRR 41% 44% #VALUE!
A B C D E
1 SIMPLE CAPITAL BUDGETING EXAMPLE
2 Discount rate 15%
3
4 Year Cash flow
5 0 -1,000
6 1 100
7 2 200
8 3 300
9 4 400
10 5 500
11 6 600
12
13 PV of future cash flows 1,172.13 #VALUE!
14 NPV 172.13 #VALUE!
15 IRR 19.71% #VALUE!
16
17
Discount
18
rate NPV
19 0% 1,100.00 #VALUE!
20 3% 849.34 #VALUE!
21 6% 637.67
9% 457.83 NPV of Cash Flows
22
23 12% 304.16 1,200
24 15% 172.13 1,000
25 18% 58.10
26 21% -40.86 800
27 24% -127.14 600
28 27% -202.71
29 30% -269.16 400
NPV

30 200
31
32 0
33
-200
34
35 -400
36 -3% 0% 2% 5% 7% 10% 13% 15% 18% 20% 23% 25% 28% 30%
37 Discount rate
F G
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sh Flows 22
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13% 15% 18% 20%
36 23% 25% 28% 30%
ount rate 37
A B C D E
1 RANKING PROJECTS WITH NPV AND IRR
2 Discount rate 15%
3
4 Year Project A Project B
5 0 -500 -500
6 1 100 250
7 2 100 250
8 3 150 200
9 4 200 100
10 5 400 50
11
12 NPV 74.42 119.96 #VALUE!
13 IRR 19.77% 27.38% #VALUE!
14
15 TABLE OF NPVs AND DISCOUNT RATES
Project A Project B
16
NPV NPV
17 0% 450.00 350.00 #VALUE!
18 2% 382.57 311.53 500 #VALUE!
19 4% 321.69 275.90
20 6% 266.60 242.84 400
Project A
21 8% 216.64 212.11 NPV
22 10% 171.22 183.49 300 Project B
23 12% 129.85 156.79 NPV
200
24 14% 92.08 131.84
NPV

25 16% 57.53 108.47 100


26 18% 25.86 86.57
27 20% -3.22 66.00 0
28 22% -29.96 46.66
24% -54.61 28.45
-100
29
30 26% -77.36 11.28 -200
31 28% -98.39 -4.93 0% 5% 10% 15% 20% 25% 30%
32 30% -117.87 -20.25
Discount rate
33
34 Calculating the crossover point
Differential cash flows:
35
Year Project A Project B cash flow(A) - cash flow(B)
36 0 -500 -500 0 #VALUE!
37 1 100 250 -150 #VALUE!
38 2 100 250 -150
39 3 150 200 -50
40 4 200 100 100
41 5 400 50 350
42
43 IRR 8.51% #VALUE!
F
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15

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Project A
21
NPV
22 B
Project
NPV
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25
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30
% 20% 31
25% 30%
32
rate
33
34

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A B C D
1 IGNORE SUNK COSTS
2 House cost 100,000
3 Fix up cost 20,000
4
Cash flow Cash flow
5
Year wrong! right!
6 0 -120,000 -20,000
7 1 90,000 90,000
8 IRR -25% 350% #VALUE!
A B C
1 SALLY & DAVE'S CONDO
2 Cost of condo 100,000
3 Sally & Dave's tax rate 30%
4
5 Annual reportable income calculation
6 Rent 24,000
7 Expenses
8 Property taxes -1,500
9 Miscellaneous expenses -1,000
10 Depreciation -10,000
11 Reportable income 11,500 #VALUE!
12 Taxes (rate = 30%) -3,450 #VALUE!
13 Net income 8,050 #VALUE!
14
15
Cash flow, method 1:
16
Add back depreciation
17 Net income 8,050 #VALUE!
18 Add back depreciation 10,000 #VALUE!
19 Cash flow 18,050 #VALUE!
20
Cash flow, method 2:
Compute after-tax income without
21
depreciation, then add depreciation
tax shield
22 Rent 24,000
23 Expenses
24 Property taxes -1,500
25 Miscellaneous expenses -1,000
26 Depreciation 0
27 Reportable income 21,500 #VALUE!
28 Taxes (rate = 30%) -6,450 #VALUE!
29 Net income without depreciaiton 15,050 #VALUE!
30
31 Depreciation tax shield 3,000 #VALUE!
32 Cash flow 18,050 #VALUE!
33
D
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20

21

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23 This is what the net
24 income would have
been if depreciation
25
were not an expense
26 for tax purposes.
27
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29
30
31 The effect of
depreciation is to add
32
a $3,000 tax shield.
33
A B C
1 SALLY & DAVE'S CONDO--PRELIMINARY VALUATION
2 Discount rate 12%
3
4 Year Cash flow
5 0 -100,000
6 1 18,050
7 2 18,050
8 3 18,050
9 4 18,050
10 5 18,050
11 6 18,050
12 7 18,050
13 8 18,050
14 9 18,050
15 10 18,050
16
17 Net present value, NPV 1,987 #VALUE!
18 Internal rate of return, IRR 12.48% #VALUE!
A B C

1
SALLY & DAVE'S CONDO: PROFITABILITY
AND TERMINAL VALUE
2 Cost of condo 100,000
3 Sally & Dave's tax rate 30%
4
5 Annual reportable income calculation
6
Rent 24,000
7 Expenses
8 Property taxes -1,500
9 Miscellaneous expenses -1,000
10
Depreciation -10,000
11 Reportable income 11,500 #VALUE!
12 Taxes (rate = 30%) -3,450 #VALUE!
13 Net income 8,050 #VALUE!
14
Cash flow, method 1
15
Add back depreciation
16 Net income 8,050 #VALUE!
17 Add back depreciation 10,000 #VALUE!
18 Cash flow 18,050 #VALUE!
19
20 Discount rate 12%
21
22 Year Cash flow
23 0 -100,000
24 1 18,050 #VALUE!
25 2 18,050
26 3 18,050
27 4 18,050
28 5 18,050
29 6 18,050
30 7 18,050
31 8 18,050
32 9 18,050
33 10 74,050 #VALUE!
34
35 NPV of condo investment 20,017 #VALUE!
36 IRR of investment 15.98% #VALUE!
37
38 Data table--Condo IRR as function of annual rent and terminal value
39 Rent
40 15.98% 18,000
41 Terminal value --> 50,000 Err:504
42 60,000 Err:504
43 70,000 Err:504
44 =B36 80,000 Err:504
A =B36 B C
45 90,000 Err:504
46 100,000 Err:504
47 110,000 Err:504
48 120,000 Err:504
49 130,000 Err:504
50 140,000 Err:504
51 150,000 Err:504
52 160,000 Err:504
53
54 Note: The data table above computes the IRR of the condo investment for
55 $26,000 per year) and terminal value (from $50,000 to $160,000).
56 Data tables are very useful though not trivial to compute. See Chapter 30 f
D E F G H

2
3
4
5 Terminal value
Estimated resale value,
6
year 10 80,000
7 Book value 0
8 Taxable gain 80,000 #VALUE!
9 Taxes 24,000 #VALUE!
Net after-tax cash flow
10
from terminal value 56,000 #VALUE!
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37
and terminal
38 value
39
40 20,000 22,000 24,000 26,000 28,000
41 Err:504 Err:504 Err:504 Err:504 Err:504
42 Err:504 Err:504 Err:504 Err:504 Err:504
43 Err:504 Err:504 Err:504 Err:504 Err:504
44 Err:504 Err:504 Err:504 Err:504 Err:504
D E F G H
45 Err:504 Err:504 Err:504 Err:504 Err:504
46 Err:504 Err:504 Err:504 Err:504 Err:504
47 Err:504 Err:504 Err:504 Err:504 Err:504
48 Err:504 Err:504 Err:504 Err:504 Err:504
49 Err:504 Err:504 Err:504 Err:504 Err:504
50 Err:504 Err:504 Err:504 Err:504 Err:504
51 Err:504 Err:504 Err:504 Err:504 Err:504
52 Err:504 Err:504 Err:504 Err:504 Err:504
53
able above computes
54 the IRR of the condo investment for combinations of rent (from $18,000 to
and terminal value
55 (from $50,000 to $160,000).
ery useful though
56 not trivial to compute. See Chapter 30 for more information.
A B C D

1
SALLY & DAVE'S CONDO: PROFITABILITY
AND TERMINAL VALUE
2 Cost of condo 100,000
3 Sally & Dave's tax rate 30%
4
5 Annual reportable income calculation Terminal value
Estimated
6 resale value,
Rent 24,000 year 10
7 Expenses Book value
8 Property taxes -1,500 Taxable gain
9 Miscellaneous expenses -1,000 Taxes
Net after tax--
10 cashflow
from terminal
Depreciation -10,000 value
11 Reportable income 11,500 #VALUE!
12 Taxes (rate = 30%) -3,450 #VALUE!
13 Net income 8,050 #VALUE!
14
Cash flow, method 1
15
Add back depreciation
16 Net income 8,050 #VALUE!
17 Add back depreciation 10,000 #VALUE!
18 Cash flow 18,050 #VALUE!
19
20 Discount rate 12%
21
22 Year Cashflow
23 0 -100,000
24 1 18,050 #VALUE!
25 2 18,050
26 3 18,050
27 4 18,050
28 5 18,050
29 6 18,050
30 7 18,050
31 8 18,050
32 9 18,050
33 10 74,050 #VALUE!
34
35 NPV of condo investment 20,017 #VALUE!
36 IRR of investment 15.98% #VALUE!
37
38 Data table--Condo IRR as function of annual rent and terminal value
39 Rent
40 15.98% 18,000 20,000
41 Terminal value --> 50,000
A B C D
42 60,000
43 70,000
44 =B36 80,000
45 90,000
46 100,000
47 110,000
48 120,000
49 130,000
50 140,000
51 150,000
52 160,000
E F G H

2
3
4
Terminal value
5

6
80,000
7 0
8 80,000 #VALUE!
9 24,000 #VALUE!

10
56,000 #VALUE!
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40 22,000 24,000 26,000 28,000
41
E F G H
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52
A B C D E F
1 BUYING A MACHINE--NPV ANALYSIS
2 Cost of the machine 800
3 Annual anticipated sales 1,000
4 Annual COGS 400
5 Annual SG&A 300 NPV Analysis
6 Annual depreciation 100 Year Cash flow
7 0 -800
8 Tax rate 40% 1 220
9 Discount rate 15% 2 220
10 3 220
11 Annual profit and loss (P&L) 4 220
12 Sales 1,000 5 220
13 Minus COGS -400 6 220
14 Minus SG&A -300 7 220
15 Minus depreciation -100 8 220
16 Profit before taxes 200 #VALUE!
17 Subtract taxes -80 #VALUE! NPV 187
18 Profit after taxes 120 #VALUE!
19
20 Calculating the annual cash flow
21 Profit after taxes 120
22 Add back depreciation 100
23 Cash flow 220
G
ANALYSIS
1
2
3
4
5
6
7 #VALUE!
8 #VALUE!
9
10
11
12
13
14
15
16
17 #VALUE!
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A B C D E F

1
BUYING A MACHINE--NPV ANALYSIS
with salvage value
2 Cost of the machine 800
3 Annual anticipated sales 1,000
4 Annual COGS 400
5 Annual SG&A 300 NPV Analysis
6 Annual depreciation 100 Year Cash flow
7 0 -800
8 Tax rate 40% 1 220
9 Discount rate 15% 2 220
10 3 220
11 Annual profit and loss (P&L) 4 220
12 Sales 1,000 5 220
13 Minus COGS -400 6 220
14 Minus SG&A -300 7 220
15 Minus depreciation -100 8 400
16 Profit before taxes 200 #VALUE!
17 Subtract taxes -80 #VALUE! NPV 246
18 Profit after taxes 120 #VALUE!
19
20 Calculating the annual cash flow
21 Profit after taxes 120
22 Add back depreciation 100
23 Cash flow 220
24
25 Calculating the cash flow from salvage value
26 Machine market value, year 8 300
27 Book value, year 8 0
28 Taxable gain 300 #VALUE!
29 Taxes paid on gain 120 #VALUE!
30 Cash flow from salvage value 180 #VALUE!
G
ANALYSIS 1

2
3
4
5
6
7 #VALUE!
8 #VALUE!
9
10
11
12
13
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15 #VALUE!
16
17 #VALUE!
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A B C D E F

BUYING A MACHINE--NPV ANALYSIS


1 with salvage value
Machine sold at end of year 7
2 Cost of the machine 800
3 Annual anticipated sales 1,000
4 Annual COGS 400
5 Annual SG&A 300 NPV Analysis
6 Annual depreciation 100 Year Cash flow
7 0 -800
8 Tax rate 40% 1 220
9 Discount rate 15% 2 220
10 3 220
11 Annual profit and loss (P&L) 4 220
12 Sales 1,000 5 220
13 Minus COGS -400 6 220
14 Minus SG&A -300 7 530
15 Minus depreciation -100
16 Profit before taxes 200 #VALUE! NPV 232
17 Subtract taxes -80 #VALUE!
18 Profit after taxes 120 #VALUE!
19
20 Calculating the annual cash flow
21 Profit after taxes 120
22 Add back depreciation 100
23 Cash flow 220
24
25 Calculating the cash flow from salvage value
26 Machine market value, year 7 450
27 Book value, year 7 100
28 Taxable gain 350 #VALUE!
29 Taxes paid on gain 140 #VALUE!
30 Cash flow from salvage value 310 #VALUE!
G

ANALYSIS
1
year 7
2
3
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5
6
7 #VALUE!
8 #VALUE!
9
10
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14 #VALUE!
15
16 #VALUE!
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A B C D E F

BUYING A MACHINE--NPV ANALYSIS


1 with salvage value
Machine sold at end of year 7
2 Cost of the machine 800
3 Annual anticipated sales 1,000
4 Annual COGS 400
5 Annual SG&A 300 NPV Analysis
6 Annual depreciation 100 Year Cash flow
7 0 -800
8 Tax rate 40% 1 220
9 Discount rate 15% 2 220
10 3 220
11 Annual profit and loss (P&L) 4 220
12 Sales 1,000 5 220
13 Minus COGS -400 6 220
14 Minus SG&A -300 7 290
15 Minus depreciation -100
16 Profit before taxes 200 #VALUE! NPV 142
17 Subtract taxes -80 #VALUE!
18 Profit after taxes 120 #VALUE!
19
20 Calculating the annual cash flow
21 Profit after taxes 120
22 Add back depreciation 100
23 Cash flow 220
24
25 Calculating the cash flow from salvage value
26 Machine market value, year 7 50
27 Book value, year 7 100
28 Taxable gain -50 #VALUE!
29 Taxes paid on gain -20 #VALUE!
30 Cash flow from salvage value 70 #VALUE!
G

ANALYSIS
1
year 7
2
3
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5
6
7 #VALUE!
8 #VALUE!
9
10
11
12
13
14 #VALUE!
15
16 #VALUE!
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A B C

1
DON'T FORGET THE COST OF
FOREGONE OPPORTUNITIES
2 Discount rate 12%
3
4 Year Cash flow
5 0 -300
6 1 185
7 2 249
8 3 155
9 4 135
10 5 420
11
12 NPV 498.12 #VALUE!
13 IRR 62.67% #VALUE!
14
15
16 Discount rate 12%
17
18 Year Cash flow
The $300 direct cost + $200
19
0 -500 <-- value of the existing machines
20 1 185
21 2 249
22 3 155
23 4 135
24 5 420
25
26 NPV 298.12
27 IRR 31.97%
A B
1 SELL THE PHOTOCOPIER OR FIX IT UP?
2 Annual cost savings (before tax) after fixing up the machine 8,000
3 Book value of machine 15,000
4 Market value of machine 5,000
5 Rehab cost of machine 17,000
6 Tax rate 40%
7 Annual depreciation if machine is retained 3,000
8 Annual copying costs
9 In-house 25,000
10 Outsourcing 33,000
11 Discount rate 12%
12
13 Alternative 1: Fix up machine and do copying in-house
14 Year Cash flow
15 0 -10,200
16 1 -13,800
17 2 -13,800
18 3 -13,800
19 4 -13,800
20 5 -13,800
21 NPV of fixing up machine and in-house copying -59,946
22
23 Alternative 2: Sell machine and outsource copying
24 Year Cash flow
25 0 9,000
26 1 -19,800
27 2 -19,800
28 3 -19,800
29 4 -19,800
30 5 -19,800
31 NPV of selling machine and outsourcing -62,375
32
33
34 Subtract Alternative 2 CFs from Alternative 1 CFs
35 Year Cash flow
36 0 -19,200
37 1 6,000
38 2 6,000
39 3 6,000
40 4 6,000
41 5 6,000
42 NPV(Alternative 1 - Alternative 2) 2,429
C
PIER OR FIX
1 IT UP?
2
3
4
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7
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9
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14
15 #VALUE!
16 #VALUE!
17
18
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20
21 #VALUE!
22
23
24
25 #VALUE!
26 #VALUE!
27
28
29
30
31 #VALUE!
32
33
34
35
36 #VALUE!
37 #VALUE!
38
39
40
41
42 #VALUE!
A B C D E
1 CAPITAL BUDGETING WITH ACCELERATED DEPRECIATION
2 Machine cost 10,000
3 Annual materials savings, before tax 3,000
4 Salvage value, end of year 5 4,000
5 Tax rate 40%
6 Discount rate 12%
7
8 Accelerated depreciation schedule (ACRS)
ACRS
9 depreciation Actual Depreciation
Year percentage depreciation tax shield
10 1 20.00% 2,000 800 #VALUE!
11 2 32.00% 3,200 1,280 #VALUE!
12 3 19.20% 1,920 768 #VALUE!
13 4 11.52% 1,152 461 #VALUE!
14 5 11.52% 1,152 461
15 6 5.76% 576 230 The book value at the end of ye
16 6 is the initial cost of the machi
17 Terminal value ($10,000) minus the sum of all
Year 6 sale price, estimated 4,000 #VALUE! the depreciation taken on the
18
machine through year 6 ($9,42
19 Year 6 book value 576 #VALUE!
20 Taxable gain 3,424 #VALUE!
21 Taxes 1,370 #VALUE!
Net cash flow from terminal value 2,630 #VALUE! The net cash flow from the
22
terminal value equals the year
23 sale price minus applicable ta
24
25 Net present value calculation
After-tax cost Depreciation
26
Year Cost savings tax shield Terminal value
27 0 -10,000
28 1 1,800 800
29 2 1,800 1,280
30 3 1,800 768
31 4 1,800 461
32 5 1,800 461
33 6 2,630
34
35 Net present value 657 #VALUE!
36 IRR 14.36% #VALUE!
F G
RATED DEPRECIATION
1
2
3
4
5
6
7
8

10
11
12
13
14
The book value15 at the end of year
16cost of the machine
6 is the initial
($10,000) minus
17 the sum of all
the depreciation
18 taken on the
machine through year 6 ($9,424).
19
20
21
The net cash 22 flow from the
terminal value equals the year 6
23
sale price minus applicable taxes.
24
25

26
Total cash flow
27 -10,000
28 2,600 #VALUE!
29 3,080
30 2,568
31 2,261
32 2,261
33 2,630
34
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36