Operations Management

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Subject: Operations Mangement

Computing After-tax Cash Flows
Determining the cash flow pattern for each project being considered is a critical step in capital investment analysis. In fact, the computation of cash flows may be the most critical step in the capital investment process. Erroneous estimates may result in erroneous decisions, regardless of the sophistication of the decision models being used. Two steps are needed to compute cash flows: (1) Forecasting revenues, expenses, and capital outlays and (2) Adjusting these gross cash flows for inflation and tax effects. Of the two steps, the more challenging is the first. Forecasting cash flows is technically demanding, and its methodology is typically studied in management science and statistics courses. It is important to understand that estimating future cash flows involves considerable judgment on the part of managers. Once gross cash flows are estimated, they should be adjusted for significant inflationary effects. Finally, straightforward applications of tax law can then be used to compute the after-tax cash flows. At this level of study, we assume that gross cash forecasts are available and focus on adjusting forecasted cash flows to improve their accuracy and utility in capital expenditure analysis. Assuming that inflation-adjusted gross cash flows are predicted with the desired degree of accuracy, the analyst must adjust these cash flows for taxes. To analyze tax effects, cash flows are usually broken into three categories: (1) Initial cash outflows needed to acquire the assets of the project, (2) Cash flows produced over the life of the project (operating cash flows), and (3) Cash flows from the final disposal of the project. Cash outflows and cash inflows adjusted for tax effects are called net cash outflows and inflows. Net cash flows include provisions for revenues, operating expenses, depreciation, and relevant tax implications. They are the proper inputs for capital investment decisions.

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Subject: Operations Mangement
 After-Tax Cash Flows: Year 0 The net cash outflow in Year 0 (the initial out-of-pocket outlay) is simply the difference between the initial cost of the project and any cash inflows directly associated with it. The gross cost of the project includes such things as the cost of land, the cost of equipment (including transportation and installation), taxes on gains from the sale of assets, and increases in working capital. Cash inflows occurring at the time of acquisition include tax savings from the sale of assets, cash from the sale of assets, and other tax benefits such as tax credits.  After-Tax Operating Cash Flows: Life of the Project In addition to determining the initial out-of-pocket outlay, managers must also estimate the annual after-tax operating cash flows expected over the life of the project. If the project generates revenue, the principal source of cash flows is from operations. Operating cash inflows can be assessed from the project’s income statement. The annual after -tax cash flows are the sum of the project’s after-tax profits and its noncash expenses.  After-Tax Cash Flows: Final Disposal At the end of the life of the project, there are two major sources of cash: (1) Release of working capital and (2) Preparation, removal, and sale of the equipment (salvage value effects). Any working capital committed to a project is released at this point. The release of working capital is a cash inflow with no tax consequences.

Operations Management Homework Help from Classof1.com
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Operations Management Homework Help from Classof1.com
*The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for
submitting the same in lieu of their academic submissions for grades.

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