Analysis and Evaluation of Inv.

Project

Lecture 1, After Mid Term

Chapter 11 (Gitman) Capital Budgeting Cashflow

Presented by:
Dr. Mohamed Sameh
After Mid Term

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Finding the Operating Cash
Inflows
 Finding the Operating Cash
Inflows
The benefits expected from a capital expenditure or “project”
It should be: incremental after-tax cash inflows

• Must be measured on an after-tax basis, because the firm will not

have the use of any benefits until it has satisfied the government’s
tax claims.
• deducting taxes before making comparisons between proposed
investments is necessary for consistency when evaluating capital
expenditure alternatives.
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 Finding the Operating Cash
Inflows
The benefits expected from a capital expenditure or “project”
It should be: incremental after-tax cash inflows

• All benefits expected from a proposed project must be measured on a cash

flow basis.
• Cash inflows represent dollars that can be spent, not merely “accounting profits.”
• The basic calculation for converting after-tax net profits into operating cash inflows
requires adding depreciation (for tangible assets) and any other noncash charges such
as amortization (Intangible assets) and depletion (Natural Resources ex: Oil Well)
deducted as expenses on the firm’s income statement back to net profits after taxes.

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Calculation of Operating Cash Inflows
Using the Income Statement Format

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 Example 1
• A firm is considering renewing its equipment to meet increased demand for its
product. The cost of equipment modifications is $1.9 million plus $100,000 in
installation costs.
• The firm will depreciate the equipment modifications under MACRS
(20,32,19,12,12,5%), using a 5-year recovery period. Additional sales revenue from
the renewal should amount to $1.2 million per year, and additional operating
expenses and other costs (excluding depreciation and interest) will amount to 40%
of the additional sales. The firm is subject to a tax rate of 40%.
• (Note: Answer the following questions for each of the next 6 years. And The IRR=8%)
What incremental operating cash inflows will result from the renewal? And Is this Renewing
decision will be True (Using NPV Method)?

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 Answer
• Incremental profits before depreciation and tax = Revenue - Expenses
= $1,200,000 – (1,200,000 X 0.40)
= $1,200,000 – $480,000 = $720,000 each year
Year (1) (2) (3) (4) (5) (6)
Profits before depr. & taxes (PBDT) $720,000 $720,000 $720,000 $720,000 $720,000 $720,000
*0.2 *0.32 *0.19 *0.12 *0.12 *0.05
- Depr. (for 2 m$)
400,000 640,000 380,000 240,000 240,000 100,000
= Net profits before taxes (NPBT) 320,000 80,000 340,000 480,000 480,000 620,000
- Tax (40%) 128,000 32,000 136,000 192,000 192,000 248,000
= Net profits after taxes (NPAT) 192,000 48,000 204,000 288,000 288,000 372,000
+ Depr. 400,000 640,000 380,000 240,000 240,000 100,000
Incremental Operating cash inflows $592,000 $688,000 $584,000 $528,000 $528,000 $472,000
PV Factor 0.926 0.857 0.794 0.735 0.681 0.630
PV of Operating cash inflows $548,192 $589,616 $463,696 $388,080 $359,568 $297,360
Sum of PV of Operating Cash Inflow $2,646,512
NPV = ∑ PV Operating Cash Inflow – Initial Investment = $2,646,512 – $2,000,000 = $646,512 (Accepted)
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