Module 10: Relevant Cash Flow

Overview

• Focus on understanding relevant cash flows in investment decisions.
• Example problems illustrating key concepts.

Problem 1: Initial Investment in Fixed Assets

• Scenario: Parker and Stone Inc. plans to set up a manufacturing plant.
  • Land: Bought 9 years ago for $6 million, worth $10 million if sold today.
  • Plant Cost: $15.2 million.
  • Site Preparation: $1.3 million.
• Initial Investment Calculation:
  • Opportunity cost of land: $10 million.
  • Total plant and preparation cost: $16.5 million.
  • Total Initial Investment: $26.5 million.

Problem 2: Operating Cash Flow (OCF) Calculation

• Given Data:
  • Sales: Provided.
  • Costs: Provided.
  • Depreciation: Provided.
  • Tax Rate: Provided.
• Key Calculations:
  1. EBIT (Earnings Before Interest and Taxes):
     • Formula: Sales - Costs - Depreciation
     • Calculated EBIT: $77,196
  2. Net Income:
     • Formula: EBIT - Taxes
     • Calculated Net Income: $60,213
  3. Operating Cash Flow:
     • Formula 1: EBIT + Depreciation - Taxes
     • Formula 2: Net Income + Depreciation
     • Calculated OCF: $116,113
  4. Depreciation Tax Shield:
     • Formula: Tax Rate x Depreciation
     • Calculated Depreciation Tax Shield: $12,474

Problem 3: After-Tax Cash Flow from Asset Sale

• Asset Details:
  • Initial Cost: $404,800
  • Depreciated over 12 years (straight line to zero).
  • Used in a 7-year project, expected sale at $50,600.
  • Tax Rate: 25%
• Calculations:
  1. Annual Depreciation: $33,733
  2. Accumulated Depreciation (7 years): $236,131
  3. Book Value at Year 7: $168,669
  4. After-Tax Cash Flow from Sale:
     • Loss due to selling below book value.
     • After-Tax Salvage Value Formula: Market Value + (Book Value - Market Value) x Tax Rate
     • Calculated After-Tax Salvage Value: $80,116

Conclusion

• Completed practice on calculating relevant cash flows and understanding implications such as opportunity costs and depreciation effects.
• Emphasis on using the right formulas for different financial scenarios.

Note: Always remember to apply the correct formulas in financial calculations to determine accurate cash flow projections.