CASH FLOW ESTIMATION AND RISK ANALYSIS

Accounting and Finance

PRA MBA 81C

Dosen pengampu:
Ratna Nurhayati, S.E. M.Com.Ak. CA. PhD.

Disusun Oleh:
Sheila Syifanur Rosyida (22/498906/NEK/26554)
Rachmat Fazil Isda (22/498907/NEK/26555)
Iskandar (22/498913/NEK/26558)
Wismayanti Ginasari (22/498931/NEK/26566)
Mujaddidul Amri (22/498954/NEK/26575)
Mohammad Iqbal Baihaqi Aminuddin (22/499000/NEK/26593)

PROGRAM STUDI MAGISTER MANAJEMEN

FAKULTAS EKONOMIKA DAN BISNIS
UNIVERSITAS GADJAH MADA
YOGYAKARTA
2022
13-9
New Project Analysis
You must evaluate a proposal to buy a new milling machine. The base price is $108.000 and
shipping and installation costs would add another $12.500. The machine falls into the
MACRS 3-year class, and it would be sold after 3 years for $65.000. The applicable
depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. The machine
would require a $5.500 increase in net operating working capital (increased inventory less
increased accounts payable). There would be no effect on revenues, but pretax labor costs
would decline by $44.000 per year. The marginal tax rate is 35%, and the WACC is 12%.
Also, the firm spent $5.000 last year investigating the feasibility of using the machine.

a. How should the $5.000 spent last year be handled?

The $5.000 spent last year should be considered as a sunk cost, because this
$5.000 could not be recovered regardless of whether the project is accepted or
rejected. We should not charge this $5.000 to the project when determining its
NPV for capital budgeting purposes.

b. What is the initial investment outlay for the machine for capital budgeting purposes, that
is, what is the Year 0 project cash flow?
CAPEX = the base price of buying new milling machine + shipping and installation
costs
= 108.000 + 12.500 = 120.500

Year 0 project cash flow = CAPEX + the net operating working capital at the start
of the project
= 120.500 + 5.500 = 126.000

c. What are the project’s annual cash flows during Year 1, 2, and 3?
Annual cash flows during Year 1 = $42.518
Annual cash flows during Year 2 = $47.579
Annual cash flows during Year 3 = $85.629

d. Should the machine be purchased? Explain your answer.

Yes, the machine should be purchased as it will generate a positive net present
value of $10.840 at the WACC of 12%.
13-11
REPLACEMENT ANALYSIS
Mississippi River Shipyards is considering the replacement of an 8 year-old riveting machine
with a new one that will increase earnings before depreciation from $27.000 to $54.000 per
year. The new machine will cost $82.500, and it will have an estimated life of 8 years and no
salvage value. The new machine will be depreciated over its 5-year MACRS recovery
period, so the applicable corporate tax rate is 40%, and the firm’s WACC is 12%. The old
machine has been fully depreciated and has no salvage value. Should the old riveting
machine be replaced by the new one? Explain your answer.

Jawab:
Berdasarkan nilai positif yang diperoleh dari NPV dari arus kas yang akan terjadi selama
masa umur manfaat mesin baru atas penggantian mesin lama maka penggantian mesin
baru masih fisibel untuk dilakukan. Indikator lain yang memperkuat kesimpulan ini adalah
nilai IRR dan MIRR yang masih lebih besar dari WACC serta periode payback yang tidak
mencapai setengah umur mesin baru.
13-12
PROJECT RISK ANALYSIS
The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects.
Each costs $6.750 and has an expected life of 3 years. Annual project cash flows begin 1
year after the initial investment and are subject to following probability distribution:

Project A Project B
Probability Cash Flows ($) Probability Cash Flows ($)
0,2 6.000 0,2 -
0,6 6.750 0,6 6.750
0,2 7.500 0,2 18.000

BPC has decided to evaluate the riskier project at 12% and the less-risky project at 10%.

a. What is each project's expected annual cash flow? Project B's standard deviation (σB) is
$5.978, and its coefficient of variation (CVB) is 0,76. What are the values of σA and CVA?

Project A
Probability Cash Flows (r) P.ri r’ = r -r̂ 𝑃(𝑟−𝑟̂)2
0,2 $6.000 $0 - 750 112.500
0,6 6.750 4.050 -0 0
0,2 7.500 3.600 750 112.500
Expected Cash Flow (r̂ ) 7.650 225.000

Expected Cash Flow

𝑁
r̂ = ∑ 𝑃. 𝑟i
𝑖=1
= (0,2) . (6.000) + (0,6) . (6.750) + (0,2) . (7.500)
= 6.750

Standar Deviasi (σA)

𝑁
σA = ∑ 𝑃. 𝑟'
𝑖=1
2 2 2
= (0, 2) . (− 750) + (0, 6) . (0) + (0, 2) . (750)
= 225. 000
= 474,34

Coefficient Variation
σ
CV = 𝑟̂
474,34
= 6.750
= 0,07
 Project B
Probability Cash Flows (r) P.ri r’ = r -r̂ 𝑃(𝑟−𝑟̂)2
0,2 $0 $0 - 7.650 11.704.500
0,6 6.750 4.050 - 900 486.000
0,2 18.000 3.600 10.350 21.424.500
Expected Cash Flow (r̂ ) 7.650 33.615.000

Expected Cash Flow

𝑁
r̂ = ∑ 𝑃. 𝑟i
𝑖=1
= (0,2) . (0) + (0,6) . (6.750) + (0,2) . (18.000)
= 7.650

Standar Deviasi (σA)

𝑁
σA = ∑ 𝑃. 𝑟'
𝑖=1
2 2 2
= (0, 2) . (− 7. 650) + (0, 6) . (− 900) + (0, 2) . (10. 350)
= 33. 615. 000
= 5.797,84

Coefficient Variation
σ
CV = 𝑟̂
5.797,84
= 7.650
= 0,76

b. Based on risk-adjusted NPVs, which project should BPC choose?

NPVA = -6.750 + 6.750/(1+0,10)1 + 6.750/(1+0,10)2 + 6.750/(1+0,10)3
= 10.036,25

NPVB = -6.750 + 6.750/(1+0,12)1 + 6.750/(1+0,12)2 + 6.750/(1+0,12)3

= 11.624,01

Based on risk-adjusted NPVs, BPC should choose Project B because Project B has the
biggest NPV value.

c. If you knew that Project B's cash flows were negatively correlated with the firm's other
cash flows, but Project A's cash flows were positively correlated, how might this affect
the decision? If Project B's cash flows were negatively correlated with gross domestic
product (GDP), while A's cash flows were positively correlated, would that influence
your risk assessment?

Korelasi negatif antara arus kas Project B dengan arus kas perusahaan lainnya dapat
menurunkan risiko pada portofolio perusahaan karena adanya diversifikasi arus kas
perusahaan. Apabila arus kas Project B berkorelasi negatif dengan GDP maka akan
memberikan efek yang sama terhadap risiko portofolio perusahaan yang akan menjadi
turun. Apabila arus kas berkorelasi positif pada arus kas perusahaan lainnya maka tidak
memberikan efek penurunan risiko portofolio.
13-13
UNEQUAL LIVES
Haley’s Graphic Designs Inc. is considering two mutually exclusive projects. Both projects
require an initial investment of $10,000 and are typical average-risk projects for the firm.
Project A has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,000 at
the end of Years 1 and 2, respectively. Project B has an expected life of 4 years with
after-tax cash inflows of $4,000 at the end of each of the next 4 years, The firm’s WACC is
10%.
a. If the projects cannot be repeated, which project should be selected if Haley uses NPV
as its criterion for project selection?
Answer
Project A

𝐶𝐹1 𝐶𝐹2
NPV A = CF0 + 1 + 2
(1+𝑟) (1+𝑟)
6.000 8.000
= -10.000 + 1 + 2
(1+0,10) (1+0,10)
= (-10,000) + 5,454.55 + 6,611.57
= $ 2,066.12
·
Project B

𝐶𝐹1 𝐶𝐹2 𝐶𝐹3 𝐶𝐹4

NPV B = CF0 + 1 + 2 + 3 + 4
(1+𝑟) (1+𝑟) (1+𝑟) (1+𝑟)
4.000 4.000 4.000 4.000
= -10.000 + 1 + 2 + 3 + 4
(1+0,10) (1+0,10) (1+0,10) (1+0,10)
= (-10,000) + 3636.36 + 3305.79 + 3005.26 + 2732.05
= $ 2,679.46

Jika proyek tidak dapat diulang, maka sebaiknya Haley memilih proyek B, karena
nilai NPV yang didapatkan dari proyek B lebih besar dibandingkan dengan proyek
A.

b. Assume that the projects can be repeated and that there are no anticipated changes in
the cash flows. Use the replacement chain analysis to determine the NPV of the project
selected.
 𝐶𝐹1 𝐶𝐹2 𝐶𝐹3 𝐶𝐹4
NPV A = CF0 + 1 + 2 + 3 + 4
(1+𝑟) (1+𝑟) (1+𝑟) (1+𝑟)
6.000 8.000−10.000 6.000 8.000
= -10.000 + 1 + 2 + 3 + 4
(1+0,10) (1+0,10) (1+0,10) (1+0,10)
= (-10,000) + 5,454.55 + (-1652.89) + 4507.89 + 5464.11
= 3773.65

c. Make the same assumption as in part b. Using the equivalent annual annuity (EAA)
method, what is the EAA of the project selected?

Item Project A Project B

PV 3773,65 2679,46
N 4 4
I/YR 10% 10%
FV 0 0
EAA = PMT(10%;4;3773,65) PMT(10%;4;2679,46)

= $1.190,48 $845,29

Project A dipilih karena project A memberikan Pembayaran tahunan (EAA) yang

jauh lebih tinggi jika dibandingkan dengan project B.