C2 Outline (continued)
C3 NPV Illustrated
Year
Revenues
Expenses
1
2
$1,000
2,000
$500
1,000
Initial outlay
($1,100)
Revenues
Expenses
$1,000
500
Cash flow
$500
$1,100.00
$500 x
2
Revenues
Expenses
1
1.10
+454.55
$1,000 x
+826.45
1
1.10 2
+$181.00
NPV
$2,000
1,000
Why does the NPV rule work? And what does work mean?
C6
Cash flow
1
2
3
$200
400
600
Accumulated
1
2
3
$200
600
1,200
Year
1
2
3
4
Year
1
2
3
4
Cash Flow
Year
Undiscounted Discounted
$100$89
$100$89
10079
200168
10070
300238
10062
400300
10055
500355
Undiscounted
Discounted
Year
1
Sales
$440
$240
$160
Costs
220
120
80
Gross profit
220
120
80
Depreciation
80
80
80
140
40
35
10
$105
$30
$0
$45
Cash flow
1
2
3
$ 50
100
150
50
50
100
100
150
150
Discount rates
NPV
0%
$100
5%
68
10%
41
15%
18
20%
-2
Year
Cash flow
0
1
2
3
4
$275
100
100
100
100
60
40
20
0
20
Discount rate
40
2%
6%
10%
14%
18%
IRR
22%
Cash flows
-$252
1,431
-3,035
2,850
-1,000
at 25.00%:
NPV = _______
at 33.33%:
NPV = _______
at 42.86%:
NPV = _______
at 66.67%:
NPV = _______
computed NPV = 0:
at 25.00%:
NPV =
at 33.33%:
NPV =
at 42.86%:
NPV =
at 66.67%:
NPV =
Two questions:
$0.02
$0.00
($0.02)
IRR = 1/3
IRR = 2/3
IRR = 3/7
($0.04)
($0.06)
($0.08)
0.2
0.28
0.36
0.44
0.52
Discount rate
0.6
0.68
Year
0
160
140
120
100
80
60
40
20
0
Project A:
$350
50
100
150
200
Project B:
$250
125
100
75
50
Crossover Point
20
40
60
80
Discount rate
100
0
2%
6%
10%
14%
IRR A
18%
IRR B
22%
26%
Cash flows
$ 500
1,000
why?
C25 Problem
Cash Flows A
Cash Flows B
-$30,000
-$45,000
15,000
5,000
10,000
10,000
10,000
20,000
5,000
250,000
Payback period
= 1 + 1 + ($30,000 - 25,000)/10,000
= 2.50 years
Project B:
Payback period
= 1 + 1 + 1 + ($45,000 - 35,000)/$250,000
= 3.04 years
Cash Flow
-$30,000
25,000
15,000
To find the IRR, set the NPV equal to 0 and solve for the
discount rate:
you know?
To find the IRR, set the NPV equal to 0 and solve for the
discount rate:
$______
______
$20,000
Fixed costs
5,000
Depreciation
7,000
EBIT
Taxes (34%)
Net income
$______
2,720
$______
$50,000
30,000
$20,000
Fixed costs
5,000
Depreciation
7,000
EBIT
Taxes (34%)
Net income
$ 8,000
2,720
$ 5,280
$______
$10,000
$10,000
$10,000
NFA
21,000
______
______
Total
$31,000
$24,000
$17,000
$10,000
NWC
NWC
$10,000
$10,000
$10,000
$10,000
NFA
21,000
14,000
7,000
Total
$31,000
$24,000
$17,000
$10,000
$8,000
Depreciation
+7,000
Taxes
-2,720
OCF
$12,280
0
OCF
Chg. NWC
______
Cap. Sp.
-21,000
Total
______
$12,280
$12,280
$12,280
______
$12,280
$12,280
$______
0
OCF
Chg. NWC
-10,000
Cap. Sp.
-21,000
Total
-31,000
$12,280
$12,280
$12,280
10,000
$12,280
$12,280
$22,280
NPV
=
=
IRR
21%
PBP
2.3 years
AAR
Yes -- the NPV > 0, and the IRR > required return
sales associated with a project will be on credit, and that some costs wont be paid
at the time of investment. How?
Answer: Estimate changes in NWC. Assume:
1. Fixed asset spending is zero.
2. The change in net working capital spending is $200:
Change
S/U
A/R
$100
$200
+100
___
INV
100
150
+50
___
-A/P
100
50
(50)
___
NWC
$100
$300
sales associated with a project will be on credit, and that some costs wont be paid
at the time of investment. How?
Answer: Estimate changes in NWC. Assume:
1. Fixed asset spending is zero.
2. The change in net working capital spending is $200:
Change
S/U
A/R
$100
$200
+100
INV
100
150
+50
-A/P
100
50
(50)
NWC
$100
$300
Sales
$300
Costs
200
Depreciation
EBIT
Tax
Net Income
0
$100
0
$100
Sales
$300
Costs
200
Depreciation
EBIT
Tax
Net Income
0
$100
0
$100
= $100
Cash sales
= $300 - ____
= $200 (collections)
Cash costs
Cash sales
= $300 - 100
= $200 (collections)
Cash costs
Cash flow
Class
Examples
3-year
5-year
Autos, computers
7-year
Property Class
Year
3-Year
5-Year
7-Year
33.33%
20.00%
14.29%
44.44
32.00
24.49
14.82
19.20
17.49
7.41
11.52
12.49
11.52
8.93
5.76
8.93
8.93
4.45
MACRS %
Depreciation
20%
$_____
32%
_____
19.20%
5,760
11.52%
3,456
11.52%
3,456
5.76%
1,728
100%
$ _____
MACRS %
Depreciation
20%
$6,000
32%
9,600
19.20%
5,760
11.52%
3,456
11.52%
3,456
5.76%
1,728
100%
$30,000
$ 2,000
8,000
8,000
$18,000
All the equipment is 5-year ACRS property, and is expected to have a salvage
value of 10% of cost after 6 years.
Anticipated operating expenses are as follows:
Working Capital
$ 12,000
Water
1,500
Electricity
3,000
Labor
30,000
2,000
Gasoline
1,500
Maintenance
1,000
Insurance
1,000
Misc. Expenses
1,000
$53,000
Projected Revenues
Year
Buckets
Revenues
20,000
$60,000
20,750
62,250
21,500
64,500
22,250
66,750
23,000
69,000
23,750
71,250
Cost
$3,000
3,150
3,308
3,473
3,647
3,829
ACRS %
Depreciation
1 20.00
$3,600$14,400
2 32.00
5,7608,640
3 19.20
3,4565,184
4 11.52
2,0743,110
5 11.52
2,0741,036
6 5.76
1,0360
Book value
Year
1
Revenues
3,0003,1503,308
3,6005,7603,456
$
Taxes
Net income
3,4733,6473,829
53,00053,00053,000 53,00053,00053,000
Depreciation
EBIT
$60,000$62,250$64,500$66,750$69,000$71,250
Variable costs
Fixed costs
400$
6051
340$
2,0742,0741,036
2,008
$ 8,737$11,377
Year
0$ 3,000
1 3,150
150
2 3,308
158
3 3,473
165
4 3,647
174
5 3,829
182
6 4,020
- 3,829
Change in NWC
Year
0
EBIT
$
+ Depreciation
$
Taxes
$
Operating
= cash flow
$
400
3,600
60
3,940
340
5,760
51
6,049
4,736
3,456
710
7,482
8,203
2,074
1,230
9,047
10,279
2,074
1,542
10,811
13,385
1,036
2,008
12,413
Year
0
OCF
$
$ 3,000
$18,000
$21,000
3,940
150
3,790
6,049
158
5,891
7,482
165
7,317
9,047
174
8,873
10,811
182
10,629
12,413
3,829
1,530
17,772
Let:
OCF = operating cash flow
S = sales
C = operating costs
D = depreciation
T = corporate tax rate
OCF
(S - C) (1 - T) + (D T)
(S - C) (1 - T) + Depreciation x T
OCF
(S - C - D) (1 - T) + D
OCF
(S - C) - (S - C - D) T
See if we can calculate the projects NPV and payback period. Assume:
See if we can calculate the projects NPV and payback period. Assume:
0
OCF
Chg. in NWC
-40
Cap. Sp.
-60
-$100
$39.8
$39.8
$39.8
40
$39.8
$39.8
$79.8
0
OCF
Chg. in NWC
40
Cap. Sp.
60
100
$39.8
$39.8
$39.8
40
$39.8
$39.8
$79.8