Andrew Wolford
BYS330 Principles of Finance
Week Four Assignment March 4th, 2014
Chapter Ten Study Problem 10-4: (Payback period, NPV, PI, and IRR calculations) You are considering a project with an initial cash outlay of $80,000.00 and expected free cash flows of $20,000.00 at the end of each year for 6 years. The required rate of return for this project is 10 percent.
a. What is the project’s payback period? Remember first that payback period is the number of years needed to recover the initial cash outlay related to an investment as is determined by the number of years just prior to complete payback + the unplaid-back amount at beginning of yearfree cash flow in year payback is completed.
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Chapter Eleven Review Question 11-1: Why do we focus on cash flows rather than accounting profits in making our capital-budgeting decisions? Why are we interested only in incremental cash flows rather than total cash flows?
First, a company receives and is able to reinvest free cash flows. Accounting profits, by contrast, are shown when they are earned as opposed to when the money is actually in hand. Generally speaking, a company’s accounting profits and free cash flows are not timed to occur simultaneously. As an example, capital expenses such as vehicles, plant, and equipment are depreciated over several years with their annual depreciation subtracted from profits. Free cash flows, however, will accurately reflect the timing of benefits and costs. This in turn shows when money is received, when it can be reinvested, and when it must be paid out. When measuring cash flows, only incremental after-tax flows matter. It is important to understand what new cash free cash flows the company will receive if it decides to go ahead with a particular project. In deciding which free cash flow is actually incremental, a company has to assess itself with versus without a particular new project. A company must take care to be wary of cash flows which are diverted from existing products. Merely moving sales from one product line to a new product line does not bring anything new into the company. Also, the firm should watch for incidental or
Free cash flows of the project for next five years can be calculated by adding depreciation values and subtracting changes in working capital from net income. In 2010, there will be a cash outflow of $2.2 million as capital expenditure. In 2011, there will be an additional one time cash outflow of $300,000 as an advertising expense. Using net free cash flow values for next five years and discount rate for discounting, NPV for the project comes out to be $2907, 100. The rate of return at which net present value becomes zero i.e.
The payback period looks at a project only until the costs have been recovered. This analysis tool is often ignored because it does not take into consideration the time value of money. The time value of money limitation of the payback period can be modified by using the discounted cash flows of a project for the analysis of when the outflows will be recovered.
In this example we have a case in which years 89, 90 and 91 net income is less than net cash provided by operating activities. One of the major reasons for this appears to have been depreciating high cost of equipment. The depreciation is trending downward over the three-year period indicating less long-term assets are being purchased/capitalized to run operations. While depreciation does not involve cash, it does impact net income. In addition, account payables have been decreasing over the last two years and significant cash has been used in the last year to pay the liability. In 1990 there are significant costs associated with restructuring activities. There
The purpose of this paper is to define accounting, and identify the four basic financial statements. The paper also explains how the different financial statements are interrelated to each other and why they are useful to managers, investors, creditors, and employees.
1) Incremental cash flows are the cash flows that should be used in calculating the NPV of a project. The cash flows are changes in cash flows that occur as a direct consequence of accepting a project, not the cash flows that the company is already receiving.
Figure 7 shows how the cash-in from operating activities and cash out to investment activities are balanced through multiple accounting periods. Toyota have steadily increased profits between FY 2011 and FY 2015, but regarding FCF, it is a negative result except for 2015. It turned out that the investment was using more capital annually than the profit obtained from the business of the main business. Investing CF (-15,802,252 million yen) is larger for cumulative CF from 2011 to 2015 compared to operating CF (15,696,396 million yen), which is a deficit of -105,856 million yen in total. Even for each year, cash flow will be red in most of the year, excluding FY 2015 (Table 6). During this period, the organization is in the operating surplus and operating profit base is in surplus. Regardless of why the deficit is said, it seems to be said that the earnings have changed to assets other than cash. In addition, missing cash is covered by borrowing money, and the company almost finances the profit each year almost every
Thus, by year three the company will be making a profit off the investment as year three is 86.73 million profit by 55.35 cost giving the company a 31.38 million dollar surplus. Generally, a period of payback of three year or less is acceptable (Reference Entry) causing this project to be viable based off the payback analysis. Although, these calculations are flawed. The reason for this is because the time value of money is not taken into effect when calculating payback periods which is where IRR can further assist in a more realistic financial picture (Reference Entry).
Information based on accrual accounting has historically and empirically provided a better indication of a company’s ability to generate cash flows than information gathered under the cash method. If there is not inter-period allocation, then the information is not as meaningful and will result in a mismatching of economic benefits
1. Two commonly used methods of financial analysis are payback and present value. Payback determines the length of time for an investment to return its original cost (1). Using the assumptions stated below the payback of the Jiminy Nick wind turbine with a cost of about $3.3 million would return the investment in about four years time. Net present value summarizes the initial cost of an investment, the estimated annual cash flows, and expected salvage value, taking into account the time value of money (1). A NPV calculation for the scenario SED is reviewing equals $7,697,286 minus the investment costs of $3,318,000 totaling $4,379,286.
Calculate the Nominal Payback, the Discounted Payback, the Net Present Value and the IRR assuming:
Focus on cash flows, not profits. One wants to get as close as possible to the economic reality of the project. Accounting profits contain many kinds of economic fiction. Flows of cash, on the other hand, are economic facts.
The free cash flow method is used to gauge “a company’s cash flow beyond that necessary to grow at the current rate… [to ensure companies] make capital expenditures to continue to exist and to grow” (Drake, n.d.). Calculation of free cash flows utilizes various components, including a firm’s value, cash flow forecasts, a firm’s capital structure, the cost of capital, and/or discounted cash flows.
The use of an accounting rate of return also underscores a project 's true future profitability because returns are calculated from accounting statements that list items at book or historical values and are, thus, backward-looking. According to the ARR, cash flows are positive due to the way the return has been tabulated with regard to returns on funds employed. The Payback Period technique also reflects that the project is positive and that initial expenses will be retrieved in approximately 7 years. However, the Payback method treats all cash flows as if they are received in the same period, i.e. cash flows in period 2 are treated the same as cash flows received in period 8. Clearly, it ignores the time value of money and is not the best method employed. Conversely, the IRR and NPV methods reflect that The Super Project is unattractive. IRR calculated is less then the 10% cost of capital (tax tabulated was 48%). NPV calculations were also negative. We accept the NPV method as the optimal capital budgeting technique and use its outcome to provide the overall evidence for our final decision on The Super Project. In this case IRR provided the same rejection result; therefore, it too proved its usefulness. Despite that, IRR is not the most favorable method because it can provide false results in the case where multiple negative
Incremental cash flow is the additional operating cash flow that an organization receives from taking on a new project. A positive incremental cash flow means that the company 's cash flow will increase with the acceptance of the project.
| Below is an excerpt from the cash flow statement of a firm for fiscal year 2003: Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Amortization of software Tax benefits of employee stock plans Special charges (Gains)/losses on investments Change in operating assets and liabilities: Receivables Inventories Pension assets Other assets Accounts payable Pension liabilities Other liabilities Net cash provided by operating activities Cash flows from investing activities: Payments for plant and other property Proceeds from disposition of plant and other property Investment in software