Financial Management Ch.11 - Group 4 (3A - S1 Akuntansi).pptx

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1. Cash Flow Estimation and Other Topics in Capital Budgeting B y Group 4

2. . . . . ( C1C022079) M Nabil Ibrahim Kinanti Nindia Dwi Ananda Members of Group 4 : Alya Dwi Fitriyati Rizka Dwi Putri ( C1C022149 ) ( C1C022082 ) (C1C022101) . M Rifki Yumas Saputra ( C1C022166)

3. Estimating Cash Flow The most important and most difficult step in capital budgeting is estimating the project's cash flows-investment expenditures and annual net cash inflows once the project is underway.

4. Identifying Relevant Cash Flows Capital budgeting decisions should be based on cash flows, not accounting earnings Only incremental cash flows are relevant to the accept/reject decision The first step in cash flow estimation is to identify the relevant cash flows, defined as the specific set of cash flows that should be considered in making a decision . Mistakes often occur:

5. In capital budgeting, the difference between cash flow and accounting profit is critical. Accounting profit reflects the return on invested capital, while cash flow is the money that is actually available. For example, accounting profit may increase due to a decrease in depreciation, but actual cash flow may decrease. In capital decision-making, net cash flow, which involves adjustments for non-cash expenses, is the main focus to ensure the right decision. Cash Flow Versus Accounting Profit

6. Incremental Cash Flow Embedded Costs Opportunistic Cost Shipping and Installation Costs Externality In evaluating a project, we focus on the cash flows that occur and only if we accept the project. These cash flows, called incremental cash flows, reflect the change in the company's total cash flow that occurs as a direct result of accepting the project. 4 Specific Issues in Determining Incremental Cash Flows :

7. Change In Net Working Capital If this change is positive, as is common in project expansions, it indicates that additional financing beyond the fixed asset costs will be needed to fund the increase in current assets.

8. Terminal Year Cash Flows Operating Cash Flows Over the Project's Life Initial Investment Outlay Evaluating Capital Budgeting Projects Generally, the incremental cash flows from a particular project can be classified as follows:

9. Expansion Projects Expansion project refers to a strategic initiative undertaken by a company to invest in new assets or develop new products or services with the aim of increasing sales, entering new markets, or enhancing operational capabilities.

10. Cash Flow Analysis Initial Investment Spending Projected Cash Flows Recovery of Working Capital Estimation of Residual Value

11. Risk Assumptions and Cost of Capital Quantitative Analysis Conclusion Impact of Forecasting Errors Qualitative Factors Uncertainty in Calculations Decision-Making

12. Project Replacement Analysis In replacement analysis, the decision to replace an existing asset involves considering cash flows from the old asset and evaluating the benefits and costs of replacing it with a new one. This involves assessing factors like depreciation, salvage value, operating cost changes, tax implications, and the impact on net present value. The analysis ensures a comprehensive understanding of the financial implications and helps make informed decisions regarding asset replacement.

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14. Explanation Line 1 The top section of the table, from Row 1 to 5, explains the cash flows occurring at (almost) t = 0, which is at the time of the investment. Line 2 Here, we are showing the price received from the sale of the old equipment. Line 3 As the old equipment will be sold below its book value, a loss will occur, reducing the company's taxable income and consequently affecting the payment of the next quarterly income tax. Line 4 The investment in additional net working capital (the new current asset requirement minus the increase in trade debt and accruals) is shown here.

15. Line 5 Here, we demonstrate the total net cash outflow at the time of replacement. Line 6 Part II of the table displays the incremental operating cash flows or the expected benefits if the replacement is carried out. Line 7 The base depreciation of the new machine at $12,000, multiplied by the MACRS allowance for a 3-year property, yields the depreciation figure shown in Row 7. Line 8 Row 8 shows the straight-line depreciation of $500 for the old machine.

16. Line 9 The depreciation expense for the old machine shown in Row 8 might not occur if the replacement is carried out, but the depreciation for the new machine will take place. Line 10 The change in depreciation results in a tax reduction equal to the change in depreciation multiplied by the tax rate. Line 11 Here, it shows the net operating cash flow over the five-year project life. Line 12 Part III illustrates the cash flows associated with the project's termination. To begin with, Row 12 shows the estimated salvage value of the new machine at the end of the project's life, which is $2,000.

17. Line 13 As the book value of the new machine at the end of Year 5 is zero, the company must pay taxes of $2,000 * 0.4 = $800. Line 14 The investment in additional net working capital of $1,000 is shown as an outflow at t = 0. Line 15 Here, it shows the total cash flow stemming from the termination of the project. Line 16 Part IV shows, in Row 16, the total net cash flow in a format suitable for capital budgeting evaluation. Essentially, Row 16 represents the timeline.

18. The capital budgeting principles used in analyzing replacement projects also apply when a company decides whether it's advantageous to call their existing bonds and replace them with new bonds bearing a lower coupon rate. The evaluation involves comparing the cost of refinancing (including call premiums and flotation costs for issuing new bonds) against the present value of interest savings by calling high-coupon bonds and replacing them with new bonds at a lower coupon rate. This comparison helps determine the financial benefit of the refinancing decision.

19. Comparing P rojects W ith D ifferent A ges What is the Replacement Chain Method? The replacement chain method is a capital budgeting decision model that compares two or more mutually exclusive capital proposals with unequal lifetimes . This methodology involves determining the number of years of cash flow (project life span) for each project and creating a "replacement chain," or iteration, to fill in the gaps in shorter-lived projects.

20. The equal annual annuity approach is one of two methods used in capital budgeting to compare mutually exclusive projects with unequal lives. What is the Equal Annual Annuity Approach? The EAA approach uses a three-step process to compare projects. The present value of the constant annual cash flows is exactly equal to the net present value of the project.

21. Inflation is a condition in which the prices of goods and services generally increase continuously. In the context of capital budgeting decisions, understanding inflation is crucial as it can significantly affect the planning and execution of capital projects. Inflation Effect of Inflation on Capital Budgeting 1.Revenue and Profit Projections 2.Revenue and Profit Projections 3.Revenue and profit projections

22. Thank You! Any questions?