Expert answer:Forecast the Cash Flows

Solved by verified expert:M6: Forecast the Cash Flows Part B – Last week, you forecasted the cash flows related to starting a business with a hot dog cart. (Please see M5 attachment for the forecasted analysis from the week prior). Use each of the methods learned this week to calculate the terminal cash flow and make a decision whether the hot dog cart venture should be a go or a no-go decision.
module_5_slides__1_.pptx

module_6_slides.pptx

m5_week_one_assignment_hot_dog_cart.docx

Unformatted Attachment Preview

FINC 560
Corporate Financial Decision Making
Module 5a: Capital Budgeting Part 1
Capital Budgeting
Capital Asset: an asset used in
the production of goods or
services.
Capital Budget: a plan for
expenditures on capital assets.
Capital Budgeting: the process of
determining how much to spend
and which capital assets to buy.
Capital Budgeting Process
• As with all corporate financial decisions, the process is cash flow based
• Steps:
1.
Determine
the change in
cash flows from
the investment.
2.
Forecast
the amounts and
timing of the
cash flows.
3.
Analyze
the cash flows to
decide whether to
invest in the asset.
Forecasting the Relevant Cash Flows
• There are three cash flows related to a capital asset: the cost
of buying it, using it, and selling it
• In more formal terms:
•
Net Cash Outlay: the cash outflow from buying and
installing the new asset, and selling the old asset (covered
in this module)
Forecasting the Relevant Cash Flows
•
Operating Cash flows: the marginal*, after-tax cash
inflows from the operation of the asset over its useful
economic life (covered in this module)
*Marginal = cash flownew – cash flowold
• Terminal Cash flow: the cash inflow from the sale of the
asset at the end of its useful economic life (covered in the
next module)
FINC 560
Corporate Financial Decision Making
Module 5b: Net Cash Outlay
The Net Cash Outlay
+ Cost of the new asset
+ Installation cost
– Proceeds on sale of the old asset
± Taxes on proceeds of the old asset*
± Change in net working capital*
= Net cash outlay
*Issues
Tax Effects
Issue 1: + Taxes on proceeds on sale: tax effects of selling the old
asset
•
VARIABLES: book value, purchase price, selling price, recaptured
depreciation
•
Book value: The purchase price of the assets less depreciation to
date
•
Purchase price: the purchase price of the asset being sold
•
Selling price: the proceeds on sale of the asset being sold
•
Recaptured depreciation: the firm may recover some depreciation
expense when the asset is sold
Tax Effects
POSSIBLE TAX EFFECTS:
• None: proceeds on sale = book value (exchanging one
asset for another asset of the same value)
• Capital loss: proceeds on sale are less than book value:
results in a tax credit at the capital gains tax rate (15%)
Tax Effects
• Capital gain: proceeds on sale are greater than the
purchase price; taxed at the capital gains tax rate (15%)
• Recaptured depreciation: proceeds on sale are greater
than book value but less than purchase price: company
recaptures some of the depreciation cost; taxed at the
ordinary income tax rate (30%)
Tax Effects: the Cash Distribution Table
To find the tax effects of selling the asset being replaced, we use the cash
distribution table.
+ BV
Distribution
Calculation
Tax effect
given
none
none
+ CG POS > PP?
POS – PP
CG tax rate (15%)
– CL
POS < BV? POS – BV CG tax rate (15%) + RD what’s left POS – BV – CG + CL Income tax rate (30%) = POS POS Total taxes BV = book value POS = proceeds on sale CG = capital gain PP = purchase price CL = capital loss RD = recaptured depreciation The Cash Distribution Table 1. Put the proceeds on sale at the bottom of the distribution column, then distribute the proceeds, working from the top down. 2. Complete the calculations identified in the calculation column. 3. Multiply the values in the calculation column by the tax rates in the tax effect column. 4. Add the values in the tax effect column to find the total taxes or tax credits from the sale. The Cash Distribution Table • Example 1: Proceeds on sale ($100,000) = book value ($100,000) Distribution Tax effect BV 100,000 0 CG 0 0 CL 0 0 RD 0 0 POS 100,000 0 The Cash Distribution Table • Example 2: Proceeds on sale ($80,000) < book value ($100,000) Distribution Tax effect BV 100,000 0 CG 0 0 CL (20,000) (20,000) * 0.15 = (3,000) RD 0 0 POS 80,000 (3,000) The Cash Distribution Table • Example 3: Proceeds on sale ($115,000) > Purchase price ($100,000)
[assume bv is $60,000]
Distribution
Tax effect
BV
60,000
0
CG
15,000
15,000 * 0.15 = 2,250
CL
0
0
RD
40,000
40,000 * 0.30 = 12,000
POS $115,000
$14,250
The Cash Distribution Table
•
Example 4: Proceeds on sale ($100,000) > book value ($60,000) but < purchase price ($120,000) Distribution Tax effect BV 60,000 0 CG 0 0 CL 0 0 RD 40,000 40,000 * 0.30 = 12,000 POS 100,000 12,000 Working Capital Issue 2: + Change in working capital • Working capital = short-term assets and liabilities • Replacing a capital asset – whether it's a machine, a factory, or another company - can have an impact on the firm's working capital. Working Capital The easiest way to understand the impact of the change in working capital on cash flows is to think of it as a change in inventory: • ↑ inventory: use cash to buy inventory = cash outflow • ↓ inventory: don't have to keep as much on hand = cash inflow Net Cash Outlay • Example 5: NJ Best, Inc. Cost of new asset Installation cost ↓ Working Capital $450,000 10,000 9,000 Old asset BV 0 POS 50,000 PP 200,000 Net Cash Outlay Solution Distrib. Tax Effects BV 0 CG 0 0 CL 0 0 RD 50,000 15,000 POS 50,000 15,000 Cost of New Asset Installation Costs Proceeds on Sale, Old Asset Taxes on Proceeds on Sale ↓ in Working Capital Net Cash Outlay 450,000 10,000 (50,000) 15,000 (9,000) 416,000 FINC 560 Corporate Financial Decision Making Module 5c: Marginal Operating Cash Flows Marginal Operating Cash Flows After we've calculated the net cash outlay, we forecast the cash flows from the operation of the new asset over its useful economic life • Marginal operating cash flows: cash flowsnew asset – cash
flowsold asset
Marginal Operating Cash Flows
Cash flow: net income + expensesnoncash
Depreciation: depreciation expense affects cash
flows because it decreases the firm’s taxes.
However, since it is a non-cash expense, it is added
back to find the operating cash flow.
Depreciation
•
Example 6:
No depreciation Depreciation
1,000
1,000
Sales
0
200
Depreciation
1,000
800
Operating income
300
240
Taxes (30%)
700
560
Net income
Depreciation
expense
decreases taxes
Depreciation
•
After subtracting it to find the tax effect, we add it back to net income to
get cash flows
•
Example 7:
Sales
Depreciation
Operating income
Taxes (30%)
Net income
Depreciation
Operating cash flow
1,000
200
800
240
560
200
760
Depreciation
• We will be using straight-line depreciation:
• Straight-line depreciation = Cost of new asset/years in asset’s
life
• Example 8: An asset costs $1,000,000, and has a useful life of
5 years. What is the annual depreciation expense for this
asset?
Depreciation expense = 1,000,000/5 = $200,000
Marginal Operating Cash Flows
+ Projected revenuenew asset
– Projected operating expensesnew asset
– Depreciation expensenew asset
= Operating incomenew asset
– Taxes
= Net incomenew asset
+ Depreciation expensenew asset
= Operating cash flownew asset
– Operating cash flowold asset
= Marginal operating cash flownew asset
Forecasting Operating Cash Flows
Relevant calculations:
•
Operating incomenew asset = sales – total operating expenses
•
Taxes = operating incomenew asset x income tax rate
•
Net income = operating incomenew asset – taxes
•
Operating cash flow = net incomenew asset + non-cash expensesnew asset
•
Marginal operating cash flownew asset = OCFnew asset – OCFold asset
Forecasting the Relevant Cash Flows
Example 9: Returning to NJ Best, Inc., recall that the new asset costs
$450,000 and has a useful life of three years. Below is the
information for its marginal cash flows
Revenues
Expenses
Expense Inflation Rate
Cost of new asset
Operating Cash Flows, Old Asset
2018
2019
2020
299,000 389,000 429,000
128,570
10%
10%
450,000
100,000 100,000 100,000
Marginal Operating Cash Flows: NJ Best, Inc.
•
Solution
(Depreciation = $450,000/3)
Revenues
Operating Expenses
Depreciation Expense
Earnings Before Taxes
Taxes
Net Income
Depreciation Expense
Operating Cash Flow
Operating Cash Flow, Old Asset
Net Operating Cash Flows
2018
299,000
128,570
150,000
20,430
6,129
14,301
150,000
164,301
100,000
64,301
2019
389,000
141,427
150,000
97,573
29,272
68,301
150,000
218,301
100,000
118,301
2020
429,000
155,570
150,000
123,430
37,029
86,401
150,000
236,401
100,000
136,401
FINC 560
Corporate Financial Decision Making
Module 6a: Capital Budgeting 2
Terminal Cash Flow
Capital Budgeting 2
•
In Module 5, you learned to forecast the net cash outlay
and operating cash flows. In this module, we will cover
calculating the terminal cash flow, as well as analyzing
the cash flows.
•
Recall that a firm will buy an asset (net cash outlay),
use it over its useful life (marginal operating cash flows),
and then sell it (terminal cash flow)
Forecasting the Terminal Cash Flow
•
Terminal Cash Flow: the cash inflow from the sale or disposal of
the asset at the end of its useful economic life
•
Three cash flows:
•
The amount for which the asset can be sold
•
The taxes on the sale of the asset, if any*
•
Returning working capital to the state it was in before the asset
was purchased**
* Use the cash distribution table
** If working capital increased (decreased) in the net cash outlay, it must
be decreased (increased) in the terminal cash flow
Forecasting the Terminal Cash Flow
Returning working capital to the state it was in before the asset was
purchased in Year 0:
Net Cash Outlay
Terminal Cash Flow
• Inflows are negative;
outflows are positive
• ↑ working capital: positive
• ↓ working capital: negative
• Inflows are positive;
outflows are negative
• ↓ working capital: positive
• ↑ working capital: negative
Forecasting the Terminal Cash Flow
Example 1: Suppose we purchased an asset that produced our product
faster. We had to keep an extra $10,000 in inventory on hand, which would
increase our working capital:
Net Cash Outlay
• ↑ working capital: add
$10,000 to the net
cash outlay
Terminal Cash Flow
• ↓ working capital: add
$10,000 to the terminal
cash flow
Forecasting the Terminal Cash Flow
Example 2: Returning to NJ Best in Module 5, we had a $9,000 decrease in
working capital; in the terminal cash flow, we must increase our working
capital by $9,000:
Net Cash Outlay
Terminal Cash Flow
• ↓ working capital:
subtract $9,000 from
the net cash outlay
• ↑ working capital:
subtract $9,000 from
the terminal cash flow
Forecasting the Terminal Cash Flow
Terminal Cash Flow:
+ Proceeds on sale of asset purchased in Year 0
+ Taxes on proceeds on sale
+ Change in working capital
= Terminal cash flow
Forecasting the Terminal Cash Flow
Example 2 (continued): Returning to NJ Best, we can sell the
asset purchased in Year 0 for $100,000. What are the tax effects
of the sale? (Recall that we depreciated the asset down to zero)
Book value
0
Capital gain
0
Capital loss
0
Recaptured depreciation
100,000
30,000
Proceeds on sale
100,000 Total taxes 30,000
Forecasting the Terminal Cash Flow
Example 2 (continued): What is the terminal cash flow for the
asset NJ Best is thinking about buying?
Proceeds on sale of asset purchased in year 0
100,000
Taxes on proceeds on sale
(30,000)
Increase in working capital
(9,000)
Terminal cash flow
$61,000
FINC 560
Corporate Financial Decision Making
Module 6b: The Go-No Go Decision
Putting It All Together: NJ Best, Inc.
Net cash outlay
Cost of new asset
Installation costs
POS, old asset
Taxes on POS
↓ working capital
Net cash outlay
2017
450,000
10,000
(50,000)
15,000
(9,000)
416,000
Operating cash flows
Revenues
Operating expenses
Depreciation expense
Earnings before taxes
Taxes
Net income
Depreciation expense
Oper. cash flow
Oper. cash flow, old asset
Net operating cash flows
Terminal cash flow
2020
POSasset purchased in 2017
Taxes on POS
↑ working capital
Terminal cash flow
100,000
(30,000)
(9,000)
61,000
2018
299,000
128,570
150,000
20,430
6,129
14,301
150,000
164,301
100,000
64,301
2019
389,000
141,427
150,000
97,573
29,272
68,301
150,000
218,301
100,000
118,301
2020
429,000
155,570
150,000
123,430
37,029
86,401
150,000
236,401
100,000
136,401
CF 1
CF 2
CF 3
CF 4
Net cash outlay
Operating cash flow
Operating cash flow
OCF + terminal cash flow
(416,000)
64,301
118,301
197,401
Capital Budgeting: the Go – No Go Decision
• Now we’ve forecasted the relevant cash flows for a capital
asset, we must analyze them and use that analysis as the
basis for a go-no go decision.
• Three methods used in the go-no go decision
• Payback period
• Net present value
• Internal rate of return
The Payback Period
•
PAYBACK PERIOD = number of years or partial years it takes to
recover the net cash outlay
•
Decision rule: choose asset with shortest payback period
•
Example 3: your company needs to buy a new machine. Below
are the cash flows for two possible replacements Which one
should you purchase?
Machine A Machine B
Net cash outlay (2,000,000) (1,500,000)
Cash inflow 1
700,000
500,000
Cash inflow 2
600,000
500,000
Cash inflow 3
500,000
500,000
Cash inflow 4
200,000
500,000
The Payback Period
•
Solution
End of Year 1
End of Year 2
End of Year 3
End of Year 4
•
Machine A
Machine B
NCO = $2,000,000 NCO = $1,500,000
700,000
500,000
600,000
500,000
1,300,000
1,000,000
500,000
500,000
1,800,000
1,500,000
200,000
2,000,000
Choose Machine B because its payback period is 3 years, while
Machine A’s is 4 years.
Net Present Value
•
NET PRESENT VALUE = PVnet cash benefits – Net cash outlay
= PVfuture cash flows – Net cash outlay
•
•
Future cash flows = Marginal OCFsusing asset + Terminal CFdisposing asset
Decision rules:
•
NPV < 0 don’t buy asset: cash outflows > cash inflows
•
NPV > 0 buy asset: cash outflows < cash inflows • NPV = 0 cash outflows = cash inflows: look at other issues Net Present Value Example 4: Should NJ Best invest in the asset for which we've calculated the relevant cash flows? (cost of capital = 0.05) CF 1 Net cash outlay CF 2 Operating cash flow CF 3 Operating cash flow CF 4 OCF + terminal cash flow (416,000) 64,301 118,301 197,401 Net Present Value Solution Calculator 2ND CE/C CF0 416000 +/- ENTER ↓ C01 64301 ENTER ↓ ↓ CF C02 118301 ENTER ↓ ↓ C03 197401 ENTER NPV ↓ I 5 ENTER ↓ CPT NPV -76,936.05 NJ Best should not buy the asset because the NPV < 0 Net Present Value /Users/ceciliaricci/Google Drive/560 Online/CAPITAL BUDGETING WORK.xlsx Excel: A Interest rate Year 0 Year 1 Year 2 Year 3 69 70 71 72 73 74 75 NPV B 5.00% 416,000 64,301 118,301 197,401 C (76,936) =NPV(B69,B71:B73)-B70 NJ Best should not buy the asset because the NPV < 0 Internal Rate of Return • INTERNAL RATE OF RETURN: actual return on an investment • COST OF CAPITAL = minimum required rate of return on any long-term investment • Decision rules: • IRR < COC don’t buy: doesn’t meet the minimum return required • IRR >= COC buy: meets the minimum return required
Internal Rate of Return
Example 5: A firm has a cost of capital of 5%. It is
considering buying a machine that will require a net cash
outflow of $150,000. It will generate cash flows of $62,000
in year 1, $53,000 in year 2, and $44,000 in year 3. Should
it invest in this asset? Justify your answer.
Internal Rate of Return
• Calculator: Uneven cash flows
CF
2ND
CE/C
CF0
150000
+/-
ENTER
↓
C01
62000
ENTER
↓
↓
C02
53000
ENTER
↓
↓
C03
44000
ENTER
IRR
CPT
IRR
3.154%
No, the IRR < COC: 3.154% < 5.0% Internal Rate of Return • Excel: A 18 19 20 21 22 23 Outlay CF 1 CF 2 CF 3 IRR B C (150,000) 62,000 53,000 44,000 3.15% =IRR(B18:B21) No, the IRR < COC: 3.154% < 5.0% You are going to start a new business selling hot dogs from a hot dog cart. Forecast the cash flows for the year in which you buy it and the next three years. Include all of the expenses related to the cart and the hot dogs. Calculate the net cash outlay, the operating cash flows. Work with your group on this assignment and one of your group members should summarize the assumptions you made in creating your forecast and post on this group discussion board. Business License Fee - 1 year $100 Vendor Cart Location License Fee - 1 year $100 Health Department Cart Inspection Fee $25 Health Department Food Handler Training Course Cost $50 Hot Dog Cart Purchase Cost $3,500 Initial Food Inventory Purchase Cost - 1 month $300 Initial Cost of Other Cart Supplies $50 Commissary Storage Fee - 1 month $50 Vendor Cart Location Rental Fee - 1 month $300 Business Supplies $10 Business Insurance - 6 months $400 Other Business Costs (Telephone, Bank) $100 Net Cash Outlay $4,985 Year 1 Cash Flow Revenue (100 hot dogs / day @ $2 for 365 days) 73,000 COGS (100 hot dogs / day @ $1 each for 365 days) -36,500 Commissary Storage Fee - 11 months -550 Vendor Cart Location Rental Fee - 11 months -3,300 Business Insurance - 6 months -400 Depreciation Expense -350 Operating Income 31,900 Taxes (15%) -4,785 Net Income 27,115 Depreciation Expense 350 Year 1 Operating Cash Flow 27,465 Year 2 Cash Flow Revenue (110 hot dogs / day @ $2 for 365 days) 80,300 COGS (110 hot dogs / day @ $1 each for 365 days) -40,150 Commissary Storage Fee - 12 months -600 Vendor Cart Location Rental Fee - 12 months -3,600 Business Insurance - 12 months -800 Depreciation Expense -350 Operating Income 34,800 Taxes (15%) -5,220 Net Income 29,580 Depreciation Expense 350 Year 2 Operating Cash Flow 29,930 Year 3 Cash Flow Revenue (121 hot dogs / day @ $2 for 365 days) 88,330 COGS (121 hot dogs / day @ $1 each for 365 days) -44,165 Commissary Storage Fee - 12 months -600 Vendor Cart Location Rental Fee - 12 months -3,600 Business Insurance - 12 months -800 Depreciation Expense -350 Operating Income 38,815 Taxes (15%) -5,822 Net Income 32,993 Depreciation Expense 350 Year 3 Operating Cash Flow 33,343 Year 4 Cash Flow Revenue (133 hot dogs / day @ $2 for 365 days) 97,090 COGS (133 hot dogs / day @ $1 each for 365 days) -48,545 Commissary Storage Fee - 12 months -600 Vendor Cart Location Rental Fee - 12 months -3,600 Business Insurance - 12 months -800 Depreciation Expense -350 Operating Income 43,195 Taxes (15%) -6,479 Net Income 36,716 Depreciation Expense 350 Year 4 Operating Cash Flow 37,066 Notes for summary net outlay 4985 Year 1 cash flow $27,465 Year 2 $29,930 9% increase since year prior Year 3 $33,343 11% increase since year prior Year 4 $37,066 11% increase since year prior overall 35% increase since year 1 Some assumptions made during forecasting: Business insurance would stay at the same rate, location an environment would stay the same throughout the years at a consistent rate, Cost of hot dogs does not rise, Assuming no employees, just one person therefore no salaries are needed. Assuming its in an area, that a hotdog stand would be (city, near a store, at an event). Assuming the owner has some business experience. Net Cash Outlay Assumptions: In our scenario the sole proprietor is new to the hotdog business and does not need to dispose of any old assets. This results in all of the items within the net cash outlay calculation appearing as expenses. These expenses take the form of equipment, initial inventory, licences and other ancillary items. We are working under the assumption that all of these items will be purchased without financing and are inclusive of all initial business expenses. Summary of Assumptions: The cash flow for the hotdog business has a steady increase between 9%-11% throughout four years. This cash flow is based upon rising revenue, consistent operational expenses, resulting in an increasing net income. We can assume a few things within this business. For starters we assume that there will be no e ... Purchase answer to see full attachment

How it works

1. Paste your instructions in the instructions box. You can also attach an instructions file
2. Select the writer category, deadline, education level and review the instructions 
3. Make a payment for the order to be assignment to a writer
4.  Download the paper after the writer uploads it 

Will the writer plagiarize my essay?

You will get a plagiarism-free paper and you can get an originality report upon request.

Is this service safe?

All the personal information is confidential and we have 100% safe payment methods. We also guarantee good grades