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Finance
Corporate Finance
Corporate Finance
Fundamental
principles
guiding
the
determination of a projects cash flows and how
they should be applied
Actual Cash-Flow Principle
Cash flows must be measured at the time
they actually occur
With/without Principle
Cash flows relevant to an investment
decision are only those that change the
firms overall cash position
Sunlight
Manufacturing
Companys
(SMC) designer desk lamp project used
to illustrate approach
Corporate Finance
Corporate Finance
Corporate Finance
Corporate Finance
EXHIBIT 8.1a:
Data
Summary
of the Designer Desk
LampTIMING
Project.
ITEM
CORRESPONDING UNITS OR VALUE
TYPE
1. Expected annual
unit sales
Revenue
End of year 1 to 5
Revenue
End of year 1 to 5
3. Consulting
companys fee
$30,000
Expense
Already incurred
4. Losses on
standard lamps
$100,000
End of year 1 to 5
5. Rental of building
to outsiders
$10,000
Revenue
End of year 1 to 5
$2,000,000
Asset
Now
Expense
End of year 1 to 5
8. Resale value of
equipment
$100,000
Revenue
End of year 5
Expense
End of year 1 to 5
7 days of sales
Asset
Now
7. Straight-line
depreciation expenses
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EXHIBIT 8.1b:
Data Summary of the Designer Desk Lamp Project.
ITEM
TYPE
TIMING
Liability
Now
Asset
Now
16 days of sales
Asset
Now
Expense
End of year 1 to 5
Expense
End of year 1 to 5
1% of sales
Expense
End of year 1 to 5
Expense
End of year 1 to 5
Expense
End of year 1 to 5
Expense
End of year 5
Not in the
cash flow
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12
13
Depreciation Expenses
Do not involve any cash outflows
Irrelevant to an investment decision
However provides for tax savings by reducing
the firms taxable profit
These tax savings are added to the projects
relevant cash flows
Tax Expenses
If an investment is profitable, the additional
tax the firm will have to pay is a relevant cash
outflow
Computed using the firms marginal
corporate tax rate
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EXHIBIT 8.2:
Investment- and Financing-Related Cash-Flow Streams
TYPE OF CASHFLOW STREAM
INITIAL
CASH FLOW
TERMINAL
CASH FLOW
NPV at
10%
$1,000
+$1,200
+$91
+$1,000
$1,100
Zero
Zero
+$100
+$91
Inflation
If inflation is incorporated in the cost of capital,
then it should also be incorporated in the
calculation of cash flows
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Where:
CFt = relevant cash flow
EBITt = contribution of the project to the Firms
Earnings Before Interest and Tax
Taxt = marginal corporate tax rate applicable to
the incremental EBITt
Dept = contribution of the project to the firms
depreciation expenses
WCRt = contribution of the project to the firms
working capital requirement
Capext = capital expenditures related to the
project
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EXHIBIT 8.3a:
Estimation of the Cash Flows Generated by the Designer Desk Lamp
Project.
Figures in thousands of dollars; data from Exhibit 8.1
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EXHIBIT 8.3b:
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EXHIBIT 8.4:
Calculation of Net Present Value for SMCs Designer Desk Lamp Project.
Figures from Exhibit 8.3
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The size of the possible annual reduction in sales and net cash
flows through sales erosion
With an estimated $100,000 yearly sales erosion, the project is
no longer a value-creating proposal
However, it can withstand some sales erosion and still have a
positive NPV
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