Brealey7ce PPT Ch09+ 3
Brealey7ce PPT Ch09+ 3
Brealey7ce PPT Ch09+ 3
Using Discounted
Cash Flow
Analysis to Make
Investment
Decisions
Prepared by
Humayun Qadri © 2020 McGraw-Hill Education Limited
MacEwan University
Learning Objectives
After studying this chapter, you should be
able to:
LO1 Identify the cash flows properly
Example:
A project costs $2,000 today and has an opportunity cost of
accounting income.
t=1 t=2
Cash Inflow +$1,500 +$500
Less: Depreciation -1,000 -1,000
Accounting Income +500 -500
500 500
Accounting income NPV 2
41.32
1.10 (1.10)
No? Yes?
Include the cash flow in the Do not include the cash flow
analysis. in the analysis.
Example:
Your firm paid $100,000 last year for a
marketing report for a new widget it has
developed.
Whether or not you pursue the new widget
project, the cash flow for the marketing report is
$100,000. © 2020 McGraw-Hill Education Limited
9
Identifying Cash Flows
IncludeOpportunity Costs: It is the benefit or
cash flow forgone as a result of an action
Suppose your firm is considering building a
factory on land owned by the firm. The market
value of the land today is $100,000. If your firm
builds the factory, there is no out-of-pocket cost
for the land.
However, there is an opportunity cost:
The opportunity cost equals the cash that could
be realized from selling the land now
($100,000).
It is a relevant cash flow for project evaluation.
© 2020 McGraw-Hill Education Limited
10
Identifying Cash Flows
Recognize the investment in working
capital:
Net working capital is the difference between a
firm’s short-term assets and liabilities
Most projects require an additional investment
in working capital (cash outflow).
For example additional inventory required to
keep up with production, or higher accounts
receivable due to increased sales.
At the end of the project, when inventories are
sold and accounts receivable are collected, the
firm has a cash inflow.
© 2020 McGraw-Hill Education Limited
11
Identifying Cash Flows
Remember Shutdown Cash Flows:
Examples:
Outflows - costs associated with closing down
coal mine and rehabilitation of their surrounding
environments.
Inflows – salvage value on sale of plant,
equipment or real estate.
where:
C= capital cost of asset acquired today
d= CCA rate for the asset class to which the asset belongs
TC = firm’s tax rate
r = discount rate
S = salvage value from sale of asset at the end of Year t
Year 0 1 2 3 4 5
Revenues 15,000 15,750 16,538 17,364 18,233