CAPITAL BUDGETING CASH FLOWS

Diorella Badel

MAJOR CASH FLOW COMPONENTSInitial investment - The relevant cash

outflow for a proposed project at time zero.Operating cash inflows - The incremental

after-tax cash inflows resulting from implementation of a project during its life.

Terminal cash flow - The after-tax non-operating cash flow occurring in the final year of a project. It is usually attributable to liquidation of the project.

FINDING THE INITIAL INVESTMENT

Key Words: cost of new asset - The net outflow necessary to acquire a new asset. installation costs - Any added costs that are necessary to place an

asset into operation. installed cost of new asset - The cost of new asset plus its

installation costs; equals the asset’s depreciable value. after-tax proceeds from sale of old asset - The difference between

the old asset’s sale proceeds and any applicable taxes or tax refunds related to its sale.

proceeds from sale of old asset - The cash inflows, net of any removal or cleanup costs, resulting from the sale of an existing asset.

tax on sale of old asset - Tax that depends on the relationship between the old asset’s sale price and book value and on existing government tax rules.

book value - The strict accounting value of an asset, calculated by subtracting its accumulated depreciation from its installed cost.

net working capital - The difference between the firm’s current assets and its current liabilities.

change in net working – capital The difference between a change in current assets and a change in current liabilities.

FINDING THE OPERATING CASH INFLOWS

FINDING THE TERMINAL CASH FLOW

SAMPLE PROBLEM:After receiving a sizable bonus from her employer, Tina

Talor is contemplating the purchase of a new car. She feels that by estimating and analyzing its cash flows she could make a more rational decision about whether to make this large purchase. Tina’s cash flow estimates for the car purchase are as follows:

Negotiated price of new car $23,500Taxes and fees on new car purchase $ 1,650Proceeds from sale of old car $ 9,750Estimated value of new car in 3 years $10,500Estimated value of old car in 3 years $ 5,700Estimated annual repair costs on new car (in warranty)Estimated annual repair costs on old car $ 400

Using the cash flow estimates, Tina calculates the initial investment, operating cash inflows, terminal cash flow, and a summary of all cash flows for the car purchase.

the many intangible benefits of owning a car. Whereas the fuel cost and basic transportation service provided are assumed to be the same with the new car as with the old car, Tina will have to decide if the cost of moving up to a new car can be justified in terms of intangibles, such as luxury and prestige.