Chapter 4 Chapter 4 Building An Incremental Cash Flow Building An Incremental Cash Flow Statement for An Investment ProjectStatement for An Investment Project

23年 4月 19日 1

Value-Oriented ManagementDefinition: the value-oriented management is defined as an emerging management

philosophy which focuses on maximizing a cash flow rather than on expanding a net income by maximizing a revenue or market share

Requirement: the added-value must be generated greater than the cost of capital in the production processes

Action Plan: to contrive a way to efficiently allocate the firm’s resources from a long-

term perspective so as to enhance the added-value in the production-marketing processes.

to figure out a way to obtain the capital necessary for business at the least cost of capital.

In order to implement the value-oriented management philosophy, the firm must estimate the cash flows and determine the cost of capital as done similarly to the DCF techniques. So, it may be called a cash flow-oriented management philosophy and its main purpose is to maximize the capital production

다.

23年 4月 19日 2

The Capital Production of Japanese Industries with respect to those of the U.S.A. Counterparties.

23年 4月 19日 3

1) cash flows from operating activities: net income + depreciation 2) cash flows from investing activities: investment, proceeds from the sale of the

fixed assets, gain taxes, working capital

3) cash flows from financing activities: money borrowed, repayment for the principal

A Cash Flow Statement for A Project

23年 4月 19日 4

Building A Cash Flow Statement

23年 4月 19日 5

opportunity costDef: (the real cost of something is what you give up to get it) The concept of opportunity cost is crucial to understanding individual choice because,

in the end, all costs are opportunity costs. That’s because every choice you make means forgoing some other alternative.

Sometimes the money you have to pay for something is a good indication of its opportunity cost. But many times it is not. One very important example of how poorly monetary cost can indicate opportunity cost is the cost of attending college. Tuition and housing are major monetary expenses for most students; but even if these things were free, attending college would still be an expensive proposition because most college students, if they were not in college, they could have a job. That is, by going to college, students forgo the income they could have made if they had worked instead. This means that the opportunity cost of attending college is what you pay for tuition and housing plus the forgone income you would have earned in a job.

It’s easy to see that opportunity cost of going to college is especially high for people who could be earning a lot during what would otherwise have been their college years. That is why star athletes like LeBon James often skip college. Some, like Tiger Woods, leave before graduation

A firm has to use all kinds of its resources like computer, land, labor, and so on to manufacture the products or services to provide for the customers and thereby it must give up using them for other alternatives. As a result, everything consumed by the firm is akin to the opportunity cost.

A Project Evaluation and Opportunity Cost

23年 4月 19日 6

ex) A firm plans to rent the idle space for 50 million won per year. But the firm will use the space to manufacture the newly developed product instead. Discuss what the opportunity cost is and why?

Sol] The 50 million won would be the opportunity cost because if the idle space had been rented, the firm would have earned that much money. So when preparing the cash flow statement for the investment analysis purpose, it must involve 50million won as a cash outflow

연간 5,000만원 임대 수익발생

연간 5,000만원 임대 수익포기

유휴공간을 임대할 경우

유휴공간을신제품개발에 사용할 경우

23年 4月 19日 7

An Example for A Project Evaluation and Opportunity Cost

EX 4.1] An Economic Evaluation for An Investment Project

Given] A marketing survey and a feasibility study: 50 million won, a cost for a purchase of a new equipment: 210 million won, A project life: 4 years, a salvage value for the equipment: 40million won, a price of a new product: 40,000won, an annual sale volume: 10,000 units, MARR=12%, Other Financial Data in The Table Below.

itemsAmount

of money

Direct labor cost(5*2hrs) 10Direct material cost(4/ton*3kg) 12*

Variable indirect cost 3Total variable cost/unit 25

Selling price 40Contribution margin/unit 15

Fixed indirect cost including depreciation 10** Profit/unit 5

(unit: 000won)

To purchase a direct material for 4,000won/ton which will be used over the next 2 years

->its current price is 6,000won/ton the fixed cost will be allocated to the product with the same pro rata as

currently done. -> to add up 15 M won of the production supervisor to the current fixed cost

23年 4月 19日 8

An Example for A Project Evaluation and Opportunity Cost

Revenue(10,000units*40)

W400,000

Expenses: D.L. C D. M. C VC FC

(10,000units*10)(30,000kg*6)(10,000units*3)

W100,000

W180,000

W30,000W15,000

Total costW325,0

00Annual Net C. F.

W75,000

(unit: 000 won)

The cash flows w. r. t. the economic evaluation

23年 4月 19日 9

An Example for A Project Evaluation and Opportunity Cost

n C. F Discount Factor (MARR=12%)

Present Value

0 -210,000 (1+0.12)0=1.000 -210,000

1 75,000 (1+0.12)-1=0.893 66,964

2 75,000 (1+0.12)-2=0.797 59,790

3 75,000 (1+0.12)-3=0.712 53,384

4 115,000 (1+0.12)-4=0.636 73,085

NPV= 43,222

IRR= 20.808%

(unit:000won)

An Economic Analysis for the Investment Project to Produce A New Product

(12%) 210,000( / ,12%,0) 75,000( / ,12%,1) 75,000( / ,12%,2)NPV P F P F P F 75,000( / ,12%,3) 115,000( / ,12%,4) 43 222,000P F P F million won

23年 4月 19日 10

An Example for A Project Evaluation and Opportunity Cost

23年 4月 19日 11

The numbers in the circle at the table below are used to calculate the present value

12

Cash Flow and Net Income

Net Income: it is a accounting tool to measure a firm’s profitability based on the accounting concept. The time at which a cash flow is incurred is completely ignored.

Cash Flow: The cash flow of today is more valuable than of tomorrow given that there is the time value of money. Therefore, when economically evaluating the investment projects, it is required to perform it based on the cash flow

23年 4月 19日

Why do we use a cash flow when Why do we use a cash flow when performing the economic analysis for the performing the economic analysis for the

investment projects: based on the investment projects: based on the mathematical conceptmathematical concept An economic profit(cash flow)

the project generates the rate of return on investment greater than the cost of capital.

the amount of the cash flow is equal to that of dividends distributed to the stockholders

Given] the capital structure: 100% of equity

the source of fund: Revenue (Rev) and the amount of money collected by issuing m stocks whose initial offering price is S

the use of fund: wage, salaries, materials, services, and so on => denoted by “W&S”

the fund balance equation at time= “t”

if there is no new stocks issued, mtSt=0 . Then, the amount of dividend at time= “t” is given by

the stock price is given by based on the dividend model.

tttttt ISWDiVSmv )&(Re Where, I=investment capital, Div= dividend

tttt ISWvDiV )&(Re

0

0 )1(

)&(Re

tt

s

ttt

k

ISWvS

00 )1(t

ts

t

k

DivS*the firm’s value based on the

dividend concept

23年 4月 19日 13

Accounting Profit(net income)

it does not consider the investment cost(I) unlike the cash flow

it considers the book value which is derived by subtracting a depreciation cost (dept) from the initial depreciation basis annually.

the net income (NIt) at time=t

the change in the book value of the fixed asset at time = “t”(net investment

capital)

it is already known that the accounting definition of profit, NIt, is different from the economic profit, DIVt. However, it can be adjusted by subtracting net investment, , as follows:

The conspicuous difference between the accounting and economic profit

the time at which a cash flow is incurred is not considered in the accounting profit concept, whereas it is clearly considered in the economic profit concept

000 )1()1(

)()&(Re

tt

s

tt

tt

s

ttttt

k

ANI

k

depIdepSWvS

Re ( & )t t t tNI v W S dep

where, dept: depreciation

tA

ttt depIA

23年 4月 19日 14

Continued………Continued………

23年 4月 19日 15

Continued………ExampleContinued………ExampleThis example shows the difference between the accounting and economic profits in terms of the business valuation

LIFO FIFOMaterial Inventory Costing System

Revenue 100 100 1st Inventory: 25 ←FIFOCOGS 90 25 2nd Inventory: 40Gross Profit 10 75 3rd Inventory: 60Tax(40%) 4 30 4th Inventory: 90 ←LIFONet Income 6 45EPS(100shares) 0.06 0.45

6( P ) 0.06 for LIFO# tan 100

=0.45 for FIFO

NetIncomeEPS Earnings erShareofCommonStockOuts ding

100 4( ) 0.96 for LIFO# tan 100

=0.70 for FIFO

CashFlowCFPS CashFlowPerShareofCommonStockOuts ding

Depreciation: it is a non-cash flow item recorded in an income statement The reason why the depreciation cost is recorded in the income

1) to deal with the depreciation cost an the expense item to identify change in the value of the fixed assets annually based on the matching principle

2) by doing so, the firms can reduces a certain amount of taxes

Ex 4.2] A Difference Between A Net Income and A Cash Flow

Given] investment cost (I)= 80 million, depreciable life(N)= 8 years, salvage value(S)=0

depreciation method(D)=straight-line depreciation method: SL, the relevant data

Item Amount

Revenue 140,000CGOS 60,000

Depreciation 10,000Operating 12,000

(unit: 000 won)

23年 4月 19日 16

Why do we use a cash flow when Why do we use a cash flow when performing the economic analysis for the performing the economic analysis for the

investment projects: based on the investment projects: based on the accounting conceptaccounting concept

Continued……….Continued……….

Find] Net Income and Cash Flow

Sol]

A depreciation cost with the SL method

the difference between the net income and the cash flow

80,000 0 108

I SD millionN

item amountIncome

statementCash flow statement

Revenue 140,000 140,000Expenses: CGOS 60,000 -60,000 Depreciation 10,000 Operatomg 12,000 12,000Taxable income 58,000Tax(25%) 14,500 -14,500Net Income 43,500Net Cash Flow 53,500

(unit: 000won)

23年 4月 19日 17

23年 4月 19日 18

Why do we use a cash flow when Why do we use a cash flow when performing the economic analysis for the performing the economic analysis for the

investment projects: based on the investment projects: based on the matching princeplematching princeple

Continued………Continued………Ex] Company A and B have the same amount of the sum of the net income and

cash flow. But Company A obtains 1 billion won of cash flow at the end of year 1 and 2, whereas Company B obtains 2 billion won at the end of year 2.

The advantage of Company A over B is that the former may generates more profit by investing 1 billion won at the end of year 1. This point is very critical to the company which wants to increase its wealth in the end.

Year A B

1Net incomeCash flow

1,000,0001,000,000

1,000,0000

2Net incomeCash flow

1,000,000 1,000,000

1,000,0002,000,000

(unit: 000 won)

23年 4月 19日 19

A Comparison of the Accounting A Comparison of the Accounting and Economic Profitsand Economic Profits

cost: costs are the monetary value of expenditures(resources consumed) services or

products. It is the sum of the direct material costs, the direct labor costs, and the

indirect manufacturing costs.expense: It is an outflow of cash or other valuable assets from a person or company to

another person or company. This outflow of cash is generally one side of a trade for

products or services that have equal or better current or future value to the buyer

than to the seller. Technically, an expense is an event in which an asset is used up or a

liability is incurred. It is the monetary value of the firm’s resources used for the

purpose of managing the firm.

23年 4月 19日 20

23年 4月 19日 21

Problem Description] Woonho works as a secretary at the big company and receives 45million won of an annual salary. And he possesses a small building and receives 9 million won of an annual renting fee and 345,000 won of an annual interest on the amount of 3.45million won for holding a CD. But he will sell the CD. He is now contemplating quitting the current work position and wants to run a pizza store at his own building which he rents..

Given] Give up the current renting fee to open the pizza store there, the disposal of the CD: 3.45 million won, Borrowing: 30 million won at the interest rate of 10%= wages, the purchase and renting charge of the equipment, and materials for the 1st year, Revenue: 127.5 million won.

accounting profit = revenue – total cost(consider the costs clearly identified) = 127,500 - 67,500 = 60 million won

Total cost: 67.5 million won=wage, the purchase and rent charge of the equipments, and materials(64.5million won)+ interest payment( 3 million won)

economic profit = revenue- total cost(consider the costs clearly identified and opportunity costs) = 127,500 – (67,500 + 57,450) = 2.44 million won opportunity cost: building renting fee(9 million won), the annual salaries foregone: 45million won,

interest from holding the CD: 3.45 million won

An Example for A Comparison of An Example for A Comparison of the Accounting and Economic the Accounting and Economic

ProfitsProfits

Building A Cash Flows StatementBuilding A Cash Flows Statement-Consider No Inflation Effect-Consider No Inflation Effect

Ex 4.3] The investment project for the automatic machining center

Given]

- Investment cost: 125 M won

- Project life: 5 years

- Annual revenue: 100 M won

- Annual Expenses:

Labor: 20 M won

Material: 12 M won

Indirect Manufacturing : 8 M won

- Annual working capital: 23 M won

- Loan: 62562.5 M won

- Loan condition: interest rate 10%, an equal payment over 5 years

- Depreciation method: Straight-Line over 8 years

- No salvage value , but 50 M won at the end of the 5th year

- tax rate: 25%

- MARR: 15%

23年 4月 19日 22

FindFind

(a) Find the after-tax cash flow

(b) What is the after-tax net present value at the MARR of 15%?

(c) Determine the annual equivalent worth and internal rate of return?

23年 4月 19日 23

The Calculations for Building A Cash Flow The Calculations for Building A Cash Flow StatementStatement

1. depreciation

Given] I: 125 M won, S: 0, Depreciation Method: SL with D.L. of 8 years

2. Gain Taxes

(125,000 0) 15.625 won8

I SD MN

( )1

5 (15,625 / )78.125

nAnnualDepreciation tt

yearMwon

Accumul ated Depreci ati on Cost

-Accumulated Depreciation Costs125,000 78,125 46.875I

Mwon

Book Val ue

50,000 46,875 3.125SalvageValue BookValue

Mwon

Gai n/ Loss

arg(0.25) (3,125) 781,300M inalTaxRate Gain

won

Gai n Taxes

23年 4月 19日 24

Calculations to Build A Cash Flows Calculations to Build A Cash Flows StatementStatement

3. Principal and Interest Repayment

1) Pay interest only during the middle of the payment schedule and pay the full amount of principal at the last time period of the payment schedule.

Ex 1] A firm borrowed 100 million won form Tongil Bank and had a contract to pay interest at 10% only during the middle of the payment schedule and pay the full amount of principal at the end of the last period of time.

nBeginning

PrincipalInterest

Principal

Repay.

Total

repayment

Ending

Principal

0 100,000

1 100,000 10,000 0 10,000 100,000

2 100,000 10,000 0 10,000 100,000

3 100,000 10,000 0 10,000 100,000

4 100,000 10,000 0 10,000 100,000

5 100,000 10,000 100,000 110,000 0

(unit: ooo won)

23年 4月 19日 25

Continued………….Continued………….

2) Pay the same amount of principal and interest over the period of a schedule time

Ex 2] A firm borrowed 125 million won from Tongil Back and pay the same amount of principal and interest at an annual rate of 10% over 5 years.

(unit:000 won)

nBeginning principal

Principal Repay.

InterestTotal

PaymentEnding

Principal0 125,000

1 125,000 25,000.00 12,500 37,500 100,000

2 100,000 25,000.00 10,000 35,000 75,000

3 75,000 25,000.00 7,500 32,500 50,000

4 50,000 25,000.00 5,000 30,000 25,000

5 25,000 25,000.00 2,500 27,500 0

23年 4月 19日 26

Continued……….Continued……….

3) Pay the same amount of money which involves the repayment and interest over the period of the schedule time

Ex 3] A firm borrowed 62.5 million won from Tongil Banl and was asked to pay the same installment at an annual interest rate of 10% over 5 years.

(unit: 000 won)

(10%) 62,500( / ,10%,5)

16,487(000 )

AE A P

won

n Beginning

principal

interest Principal

repay.

Total

payment

Ending

principal

0 62,500.00

1 62,500.00 6,250.00 10,237.34 16,487.34 52,262.66

2 52,262,66 5,226.27 11,261.08 16,487.34 41,001.58

3 41,001.58 4,100.16 12,387.18 16,487.34 28,614.40

4 28,614.40 2,861.44 13,625.90 16,487.34 14,988.49

5 14,988.49 1,498.85 14,988.49 16,487.34 0.00

23年 4月 19日 27

Continued…….Continued…….

4. Working Capital

- I t is assumed that a working capital is invested at the beginning of each year and fully recovered at the end of the year

(unit: 000 won)

N 0 1 2 3 4 5

Recovery 23,000 23,000 23,000 23,000 23,000

Investing -23,000 -23,000 -23,000 -23,000 -23,000

Net Working Capital

-23,000 0 0 0 0

23年 4月 19日 28

Income StatementIncome Statement

input MARR 15% 세율 25% Debt Interest rate: 10%

Income Statement 0 1 2 3 4 5Rev. 100,000 100,000 100,000 100,000 100,000

Exp.:

Labor 20,000 20,000 20,000 20,000 20,000

Material 12,000 12,000 12,000 12,000 12,000

Indirect Mfg 8,000 8,000 8,000 8,000 8,000

Depreciation 15,625 15,625 15,625 15,625 15,625

Interest 6,250 5,226 4,100 2,861 1,499

Taxable Income 38,125 39,149 40,275 41,514 42,876

Tax Rate(25%) 9,531 9,787 10,069 10,379 10,719

Net Income 28,594 29,362 30,206 31,136 32,157

Depreciation: SL with Depreiable Life of 8 years

(unit: 000 won)

23年 4月 19日 29

A Cash Flow StatementA Cash Flow Statement

(unit: 000 won)

Cash Flow Stat. 0 1 2 3 4 5

Operating Activities: Net Income 28,594 29,362 30,206 31,136 32,157 Depreciation 15,625 15,625 15,625 15,625 15,625Investing Activities: Investment (125,000) Salvage Value 50,000 Gain Taxes (781) Working Capital (23,000) 23,000Financing Activitieis: Borrow 62,500 Prin. Rep. (10,237) (11,261) (12,626) (13,626) (14,988)NCF (85,500) 33,982 33,726 33,205 33,135 105,013

23年 4月 19日 30

A Cash Flow Diagram for The A Cash Flow Diagram for The Automatic Machining CenterAutomatic Machining Center

0 1 2 3 4 5

85,500

33,982

33,726

33,20533,135

105,013

n

(15%) 85,500( / ,15%,0) 33,982( / ,15%,1)

33,726( / ,15%,2) 33,205( / ,15%,3)

33,135( / ,15%,4) 105,013( / ,15%,5)

62,538.5(000 )

NPV P F P F

P F P F

P F P F

won

(15%) 62,538.5( / ,15%,5)

18,656(000 )

AE A P

won

23年 4月 19日 31

The IRR for the Investment ProjectThe IRR for the Investment Project

r

Net Cash Flow

0 .2 0 .4 0 .6 0 .8 1 .0

50 00 0

50 00 0

10 0 00 0

15 0 00 0

Break_Even Interest Rate=IRR

0)1(

013,105

)1(

135,33

)1(

205,33

)1(

726,33

)1(

982,33500,85

)1()(

5*4*3*2*1*

0*

*

iiiii

i

CFiNPV

N

tt

t

23年 4月 19日 32

A Trial-Error TechniqueA Trial-Error Technique

Step 1: Guess an interest rate.

i*=18%

Step 2: Calculate NPV(i*)

Step 3: if NPV(i*) > 0,

increase i*,

if NPV(i*) < 0 이면 ,

decrease i*.

Recalculate the NPV(i*)

(18%) 50,722(000 )NPV won

(40%) 3,768(000 )NPV won

Step 4: obtain an approximate i* with extrapolation.

50,722

0

-3,768

18% i 40%

3768722,50

722,50%22%18*i

%48.38

23年 4月 19日 33

Building an incremental cash flow Building an incremental cash flow statement with inflationstatement with inflation

Ex.4.4] Automatic Machining Center Project

Financial Data]

- Investment: 125 M won

- Project Life: 5years

- Annual Revenue: 100 M won

- Annual Expense:

Labor: 20 M won

Material: 12 M won

Indirect Manufacturing: 8 M won

- Annual Working Capital: 23 M won

- Financing: 625 M won

- Loan Condition: The same annual installment at the interest rate of 10%

over 5 years

- Depreciation Methods : the SL with the depreciable life of 8 years

- No salvage value , but 50 M won at the end of the 5th year

- Tax rate: 25%

- MARR: 15%

- General inflation rate (f): 5%

23年 4月 19日 34

The Calculations to Build A Cash Flow The Calculations to Build A Cash Flow StatementStatement

1. Revenue

1st year= 100,000(1+0.05)=105 M won

2nd year= 105,000(1+0.05)=100,000(1+0.05)2=110.250 M won

……………………………………………………………………………….

5th year= 121,551(1+0.05)= 100,000(1+0.05)5=127.628 M won

2. Gain tax for the sale of the fixed asset

-the salvage value at the end of the 5th year accounted for the general inflation rate=50,000(1+0.05)5

=50,000(F/P,5%,5)=63.814 M won

- Gain/Loss=63,814-46,875=16.939 M won

- Gain tax(0.25)(16,939)=4.235 M won

23年 4月 19日 35

Continued………..Continued………..

3. Working capital

- a working capital is invested at the beginning of each year and fully recovered at the end of the year

- inflation rate: 5%

4. Market interest rate

(unit: ooo won)

n 0 1 2 3 4 5

W.C. Recovery 23,000 24,150 25,358 26,626 27,957

W.C. Invested -23,000 -24,150 -25,358 -26,626 -27,957

Net W.C. invested

-23,000 -1,150 -1,208 -1,268 -1,331

2075.0

)05.0()15.0(05.015.0

''

fifii

23年 4月 19日 36

A Cash Flow Statement Build with A Cash Flow Statement Build with Consideration of An Inflation EffectConsideration of An Inflation Effect

(unit:000 won)입력자료 　 MARR 15% 감가상각방법 : 내용연수 8 년 정률법 상환기간 : 5 년

인플레이션율 =5% 세율 25% 부채이자율 : 10% 상환방법 : 원리균등상환

손익계산서 　 　 0 1 2 3 4 5

　 매출액 5% 　 105,000 110,250 115,763 121,551 127,628

　 비용 : 　 　 　 　 　 　 　

　 임금 5% 　 21,000 22,050 23,153 24,310 25,526

　 원자재 5% 　 12,600 13,230 13,892 14,586 15,315

　 제조간접비 5% 　 8,400 8,820 9,261 9,724 10,210

　 감가상각비 　 　 15,625 15,625 15,625 15,625 15,625

　 부채이자 　 　 6,250 5,226 4,100 2,861 1,499

　 과세표준 　 　 41,125 45,299 49,733 54,444 59,453

　 법인세 (25%) 　 　 10,281 11,325 12,433 13,611 14,863

　 당기순이익 　 　 30,844 33,974 37,299 40,833 44,590

　 　 　 　 　 　 　 　 　

현금흐름표 　 　 　 　 　 　 　 　

　 영업활동 : 　 　 　 　 　 　 　

　 당기순이익 　 　 30,844 33,974 37,299 40,833 44,590

　 감가상각비 　 　 15,625 15,625 15,625 15,625 15,625

　 투자활동 : 　 　 　 　 　 　 　

　 투자 　 (125,000) 　 　 　 　 　

　 잔존가치 5% 　 　 　 　 　 63,814

　 자산처분세 　 　 　 　 　 　 (4,235)

　 운전자본 　 (23,000) (1,150) (1,208) (1,268) (1,331) 27,957

　 재무활동 : 　 　 　 　 　 　 　

　 융자액 　 62,500 　 　 　 　 　

　 원금상환 　 　 (10,237) (11,261) (12,626) (13,626) (14,988)

　 순현금흐름 　 (85,500) 35,082 37,130 39,030 41,501 132,763

NPV(20.75%)= 　 62,426.89

AW(15%)= 　 18,623

IRR= 　 44.5531%

23年 4月 19日 37