1. Estimating Project Cash Flows
Capital Budgeting
Estimating Project Cash Flows

2. The Balance Sheet (Figure 2.1)
Total Value of Liabilities
and Shareholders’ Equity
Total Value of Assets
Net
Working
Capital
Current Liabilities
Current
Assets
Long-Term Debt
Fixed Assets
1. Tangible fixed assets
2. Intangible fixed assets
Cost of Capital
Shareholders’ Equity
Income Statement

3. Incremental Cash Flows -- Items to think about
Cannibalization of other products
If a new product reduces the sales of other products, this reduction (Revenues - variable costs) is a cash outflow.
Sales Creation
Consider not only the new product, but also the possible increases in sales among other products.
Opportunity Costs
Include the market value of assets already owned. These assets have value as investments or when sold. Do not simply include them at book value or omit them.
Sunk Costs
Do not include costs that have already been incurred. Only value future cash flows, never past.

4. Incremental Cash Flows -- Items to think about (Cont.)
Transfer Prices
Prices charged between divisions must be market value. Often times accounting transfer prices are different than market prices for tax purposes.
Allocated Overhead
Accounting measures arbitrarily assign overhead costs via sales or space requirements. We should only include additional expenses that are incurred due to the implementation of this project.
Inflation
Make sure to include the affects of inflation on the cash flows. Our discount rate incorporates inflation and not including inflation in the cash flows will mean that we have undervalued the project.
Financing Costs
Do not include these in the cash flows. These are incorporated in the discount rate used.

5. T10.7 Modified ACRS Property Classes (Table 10.6)
Class Examples
3-year Equipment used in research
5-year Autos, computers
7-year Most industrial equipment
What Costs are Depreciable?
Purchase Price
Modification Costs
Delivery Costs
Installation Costs
CQ2 Given the choice, would a firm prefer to use MACRS
depreciation or straight line depreciation? Why?

6. Property Class Year 3-Year 5-Year 7-Year 1 33.33% 20.00% 14.29%
T10.8 Modified ACRS Depreciation Allowances (Table 10.7) (page 71)
Property Class
Year Year Year Year
% 20.00% 14.29%