1. Chapter 8 -- Estimating Incremental Cash Flows u Relevant Cash Flow u A cash flow that is caused by a course of action or project u Irrelevant Cash Flow u A Cash Flow that does not change as a result of a course of action

2. Relevant Cash Flows u Indirect cost -- Relationship may be fuzzy but it should be estimated u Indirect benefits -- Need to be estimated u Claims by supplier of capital -- Cost is usually taken care of in the discount rate u Interest Expense -- Cost is usually taken care of in the discount rate u Opportunity cost -- Next best course of action not taken -- could be very important

3. Irrelevant Cash Flows u Sunk cost: u These are past costs and are therefore irrelevant u Make the best use of the capacity put in place by past decisions u Pure joint cost: u Are common costs that do not change as a result of an action and are therefore irrelevant

4. 11 Steps to Estimating Cash Flows From a Project u Four groups of steps: u Estimating the Income Statement u Estimating the Balance Sheet u Rolling the Income Statement and Balance Sheet into a Cash Flow Statement u Making the Decision

5. Estimating the Income Statement u Estimate the relevant revenues and expenses u Assemble into an income statement u Remember -- Accrual accounting is not the same as cash basis accounting

6. Estimating the Balance Sheet u Determine the balance sheet accounts that are impacted u Estimate the initial size of the investment u Determine the size and growth during operations

7. Rolling the Income Statement and Balance Sheet into a Cash Flow Statement u Calculate depreciation u Estimate the life of the project u Determine terminal values for fixed assets u Determine disposal values for working capital u Construct the cash flow statement

8. Making the Decision u Calculate the present value u Make the decision

9. Estimating Balance Sheet Accounts u Accounts Receivable: u This is when you extend credit to your customers u typically occur in year 0 -- because they are closer to the beginning of the year than end u typically increase with increase in sales u credit losses are fully deductible u often liquidated at a loss

10. Estimating Balance Sheet Accounts u Inventory: u typically occur in year 0 u typically increase with increase in sales u inventory losses are fully deductible u often liquidated at a loss

11. Estimating Balance Sheet Accounts u Cash Balances: u typically occur in year 0 u typically increase with increase in sales u liquidated at full value

12. Estimating Balance Sheet Accounts u Accounts Payable: u usually associated the purchase of inventory u typically occur in year 0 u typically increase with increase in sales u are a source of cash (positive number) increases in liabilities are source of cash u often liquidated at full value

13. Estimating Balance Sheet Accounts u Accrued Expenses: u associated with employees and others u typically occur in year 0 u typically increase with increase in sales u often liquidated at full value

14. Estimating & Depreciating Land – A Balance Sheet Account u Land: u cannot be depreciated u typically occur in year 0 u only increases with additional acquisitions u may be 1250 gain or loss on disposal u disposal gains and losses are fully taxable

15. Estimating & Depreciating Buildings -- A Balance Sheet Account u Buildings: u either classified as residential or commercial u residential depreciated over 27.5 years u commercial depreciated over 39 years u must use mid-month convention u typically occur in year 0 u often liquidated with a 1250 gain or loss u disposal gains and losses are fully taxable

16. Estimating & Depreciating Equipment -- A Balance Sheet Account u Equipment: u are grouped into one of 6 asset classifications -- 3,5,7,10,15,20 year lives u find the class, use the table rates u typically occur in year 0 u often liquidated with a 1245 gain or loss u disposal gains and losses are fully taxable

17. Calculation of disposition stage gain or loss and cash flow u original purchase price - depreciation taken = remaining basis u Selling price - remaining basis = taxable gain or loss u taxable gain or loss * tax rate = taxes owed or tax refund u Cash selling price - taxes owed or + tax refund = disposition stage cash flow

18. Forecasting Sales u trend analysis u study of potential purchasers u derived demand u other methods

19. Forecasting Operating Cost, and Working Capital u Forecasting Cost: u engineering analysis u regression analysis -- fixed and variable u Forecasting Working Capital: u regression analysis -- from past relationships