Professional Documents
Culture Documents
There are many factors that affect the level and timing of project cash flows
Income statements show how well the company has performed, they do not track cash flows
Capital expenditures are depreciated as opposed to being deducted when calculating income
Current outlay may deduct the depreciation form the cash flow to obtain accounting income
When calculating NPV, we need to recognize investment expenditures when they occur, not when
they show up as depreciation
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Equals the cash that could be realized from selling the project now; it is a relevant cash
flow for project evaluation
If you use land that can otherwise be sold for $100000, you have given up that amount by
undertaking the project
Most projects entail additional investment in working capital; before starting production, a firm must
invest in inventories of raw materials
Forget that working capital is recovered at end of the project; inventories are run down, any
unpaid bills are paid and you can recover your investment in working capital
Once a project is complete, you may be able to sell some of the plant, equipment or real estate that
was dedicated to it
Some investment in working capital can be recovered by selling off inventories of finished goods and
collecting outstanding AR
Sometimes, overhead costs may not be related to a particular project, but they must be paid for
When assigning costs to firms project, a charge for overhead is usually made
Principle of incremental cash flow states that we should only include the extra expense that
would result from the project
Real cash flow must be discounted at real discount rate and nominal cash flow must be discounted at
nominal discount rate
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All cash outflows required coming from shareholders and all inflows going to them
This allows you to separate analysis of the investment decision from that of the financing decision
Calculating Cash Flows
Capital Investment
Company will need to make considerable up-front investment in PPE, research, marketing to get a
project off the ground
Cash is reduced when customers are slow to pay their bills (firm makes investment in AR)
Consists of any revenues from sale less costs of production and taxes
Some investments are there to reduce costs of existing operations (create efficiencies)
Take only the items from the income statement that represent cash flows
Start with after tax accounting profit and add back any deductions that were made for non-cash
expenses (depreciation)
Depreciation deduction does affect net profits and the amount of taxes paid
Need to get net profit assuming 0 depreciation and then add tax shield created by depreciation
all three methods for estimating operating cash flow give the same answer
Business Taxes in Canada and the Capital Budgeting Decision
businesses can deduct and amount for depreciation o its depreciable assets before calculating taxable
income
Capital cost allowance (CCA): the amount of write-off on depreciable assets allowed by CRA
against taxable income
Un-depreciated capital cost: balance remaining in an assets class that has not yet been
depreciated in that year
Only the CCA amount has an effect on the companys cash flows
Asset class: eligible depreciable assets are grouped into specified asset classes by CRA; each asset
class has prescribe CCA rate
Intangible assets or patents follow straight line depreciation method for computing CCA
Straight line depreciation: constant depreciation for each year of the assets accounting life
Declining balance depreciation: computed by applying the depreciation rate to the asset balance for
each year
Half year rule: only of the purchase cost of the asset is added to the asset class and used to
compute CCA in the year of purchase
Sales of Assets
A company is entitled to CCA as long as it owns at least one asset in the asset class
Adjusted cost of disposal: when depreciable asset is sold, undepreciated capital cost of the asset
class is reduced by sale price or initial cost
Net acquisitions rule: determine total cost of all additions to an asset class and then subtract adjust
cost of disposal of all assets in that class
If net acquisitions is positive, we would apply year rule and calculate CCA
If net acquisitions is negative, we would subtract the amount from beginning UCC balance of
the asset class
Terminal loss: positive balance following the disposal of all assets in the class. UCC of the asset class
is set to 0 after a terminal loss is recognized
Recaptured depreciation: the negative balance that is caused in an asset class by sale of an asset. It
is added to taxable income
Capital gains, net of any capital losses, are taxed at 50% of firms applicable marginal tax rate
R: discount rate
S: salvage amount from the sale of the asset
at end of year t
We seek for incremental changes in CCA and UCC that arise because of the purchase/sale of
assets for the project
For an asset to generate CCA tax shields even after it is sold: there must be other assets
remaining in the class, and the proceeds from disposing of any assets are less than total UCC for the
asset class
Example: Blooper Industries
Capital Investment
Project requires investment of $10
million in mining machinery; no further
value after five years
Revenues
Working Capital
Further Notes and Winkles Arising from Bloopers Project: salvage value will reduce future tax shields
and the PV of CCA tax shields
CRA only lets companies depreciate amount of the original investment; nominal amount of CCA is
fixed
Higher the rate of inflation, lower the real value of CCA that you can claim