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CF 473.32 12 Winter 2014

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Questions 1. What cash flows should I consider? 2. How does the market set r ? 3. How should I set r ?

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CF 1 at time 0 at CF 1 n 1 = 0

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CF 1 at time 0 at the very beginning of the project when decision to go ahead made any costs incurred to make decision ignored when added all together almost always < $0

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CF 1 at time 0 includes capital cost usually equipment shipping, installation, training, etc. everything needed to get it up & running working capital cash flotation costs start-up costs

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CF 1 at time 0 also includes present value of Capital Cost Allowance minus the CCA of salvage revenue PV CCA tax shield PV of getting working capital back PV working capital

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CF 1

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start-up costs weighted average flotation cost fafa

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Flotation Costs issuing new stocks or bonds isn’t free weighted average flotation cost f d =2% debt f e =5% equity 1/21/2.5 1/11/1 1 2/12/1 2 w d =.50 w d =.33 w d =.67 w e =.50 w e =.67 w e =.33

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Flotation Costs issuing new stocks or bonds isn’t free weighted average flotation cost use target weights over the long term, firm will issue securities in these percentages

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Flotation Costs project firm’s target D/E ratio is.6 flotation costs 5% equity 3% debt

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Flotation Costs

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you get the cash (working capital) back at end of project what’s that refund worth to you today?

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CCA tax shield t CCA CCA tax shield rate t c corporate tax rate r discount rate s salvage value n number of periods in the project

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Equipment cost c $100,000 Installation & delivery cost c $10,000 Salvage s $17,000 when? n 6 Marginal tax rate tctc 40% CCA tax rate t CCA 20% discount rate r 10% “hurdle rate”

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CF 1

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Productivity considering new production system initial cost $1 million save $300,000/yr in inventory & receivables management costs last for 5 years CCA tax shield rate of 20% salvage value of $50,000 no impact on Net Working Capital marginal tax rate is 40% required return is 8%.

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Productivity Equipment cost c equipment $1,000,000 Installation & delivery cost c installation $0 Working capital c working $0 Benefit CF 2 …CF n+1 $300,000 Salvage s $50,000 when? n 5 Flotation cost fafa 0% Marginal tax rate tctc 40% CCA tax rate t CCA 20% discount rate r 8%

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Applications cost-cutting proposals replacing an asset setting a bid price comparing equipment with different lifespans

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Cost-Cutting Proposal equip $80,000 to buy & install save $35,000 pretax lifespan 5 years NWC $0 CCA tax rate 20% salvage $0 tax rate 40% discount rate 10%

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Cost-Cutting Proposal Equipment cost c equipment $80,000 Installation & delivery cost c installation $0 Working capital c working $0 Benefit CF 2 …CF n+1 $35,000·(1- t C ) Salvage s $0 Lifespan n 5 Flotation cost fafa 0% Marginal tax rate tctc 40% CCA tax rate t CCA 20% discount rate r 10%

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Cost-Cutting Proposal

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annuity

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Replacement? original machine initial cost $150,000 purchased 4 yrs ago salvage today $50,000 salvage in 6 yrs $10,000 new machine initial cost $200,000 6-year life salvage in 6 yrs $30,000 cost savings $75,000/year net working capital $0 CCA rate = 20% required return = 15% marginal tax rate = 44% $150,000 -PV PV only question: What will be different if we do project?

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Replacement?

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Equipment cost net c equipment $150,000 Installation & delivery cost c installation $0 Working capital c working $0 Benefit CF 2 …CF n+1 $75,000·(1- T C ) Salvage net s $30,000 Lifespan n 6 Flotation cost fafa 0% Marginal tax rate tctc 44% CCA tax rate t CCA 20% discount rate r 15%

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Replacement?

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Setting a Bid Price required return 20% 5 trucks/year for 4 years truck platforms $10,000 ea facilities lease $24,000/year labor & material $4,000/truck new equipment $60,000 salvage $5,000 NWC $40,000 CCA 20% tax 43.5%

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Setting a Bid Price Equipment cost c equipment $60,000.00 Installation & delivery cost c installation $0 Working capital c working $40,000.00 Benefit CF 2 …CF n+1 $94,000.00·(1- t c ) Salvage s $5,000.00 Lifespan n 4 Flotation cost fafa 0% Marginal tax rate tctc 43.5% CCA tax rate t CCA 20% discount rate r 20%

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