Chapter 12 Capital Budgeting and Estimating Cash flows 12-1
12-1 Chapter 12 Capital Budgeting and Estimating Cash Flows
Capital Budgeting and Estimating Cash Flows n The Capital Budgeting Process n Generating Investment Project Proposals o Estimating Project After-Tax Incremental Operating Cash Flows 12-2
12-2 Capital Budgeting and Estimating Cash Flows The Capital Budgeting Process Generating Investment Project Proposals Estimating Project After-Tax Incremental Operating Cash Flows
What is Capital The process of identifying analyzing, and selecting investment projects whose returns(cash flows)are expected to extend beyond one year. 12-3
12-3 What is Capital Budgeting? The process of identifying, analyzing, and selecting investment projects whose returns (cash flows) are expected to extend beyond one year
The Capital Budgeting Process n Generate investment proposals consistent with the firm's strategic objectives o Estimate after-tax incremental operating cash flows for the investment projects o Evaluate project incremental cash flows 12-4
12-4 The Capital Budgeting Process Generate investment proposals consistent with the firm’s strategic objectives. Estimate after-tax incremental operating cash flows for the investment projects. Evaluate project incremental cash flows
The Capital Budgeting Process n Select projects based on a value maximizing acceptance criterion n Reevaluate implemented investment projects continually and perform postaudit for completed projects 12-5
12-5 The Capital Budgeting Process Select projects based on a valuemaximizing acceptance criterion. Reevaluate implemented investment projects continually and perform postaudits for completed projects
Classification of investment Project Proposals 1. New Products or expansion of existing products 2. Replacement of existing equipment or buildings 3. Research and development 4. Exploration 5. Other(e.g, safety or pollution related) 12-6
12-6 Classification of Investment Project Proposals 1. New Products or expansion of existing products 2. Replacement of existing equipment or buildings 3. Research and development 4. Exploration 5. Other (e.g., safety or pollution related)
Screening Proposals and Decision Making 1 Section chiefs Advancement 2. Plant managers to the next 3. VP for Operations level depends 4. Capital Expenditures on cost Committee and strategic 5 President importance 6. Board of directors 12-7
12-7 Screening Proposals and Decision Making 1. Section chiefs 2. Plant managers 3. VP for Operations 4. Capital Expenditures Committee 5. President 6. Board of Directors Advancement to the next level depends on cost and strategic importance
Estimating After-Tax Incremental cash flows Basic characteristics of relevant project flows M Cash(not accounting income)flows M Operating(not financing)flows 区 After-tax flows 区 Incrementa|fows 12-8
12-8 Estimating After-Tax Incremental Cash Flows Cash (not accounting income) flows Operating (not financing) flows After-tax flows Incremental flows Basic characteristics of relevant project flows
Estimating After-Tax Incremental cash flows Principles that must be adhered to in the estimation 区 lgnore sunk costs z Include opportunity costs a Include project-driven changes in working capital net of spontaneous changes in current liabilities a Include erects of ination 12-9
12-9 Estimating After-Tax Incremental Cash Flows Ignore sunk costs Include opportunity costs Include project-driven changes in working capital net of spontaneous changes in current liabilities Include effects of inflation Principles that must be adhered to in the estimation
Tax Considerations and Depreciation n Depreciation represents the systematic allocation of the cost of a capital asset over a period of time for financial reporting purposes, tax purposes, or both Generally, profitable firms prefer to use an accelerated method for tax reporting purposes MACRS) 12-10
12-10 Tax Considerations and Depreciation Generally, profitable firms prefer to use an accelerated method for tax reporting purposes (MACRS). Depreciation represents the systematic allocation of the cost of a capital asset over a period of time for financial reporting purposes, tax purposes, or both
