a.Should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits? Caledonia should focus on cash flows, not accounting profits. Free cash flows are able to be reinvested, whereas accounting profits are shown when they are earned, not when the cash is actually received. The company should be interested in incremental after-tax cash flows. The incremental cash flow will allow Caledonia to see the profits or losses of a project by comparing cash flows with and without the project on an after tax basis. b.How does depreciation affect free cash flows?

Depreciation lowers profits and in turn also lowers the taxes that are paid. c.How do sunk costs affect the determination of cash flows? Sunk costs do not affect cash flows. They are cash flows that have already occurred and won’t be considered in the incremental cash flows. d.What is the project’s initial outlay?

Cost of new asset + shipping and installation costs + working capital increase = Initial outlay $7,900,000 + $100,000 + $100,000 = $8,100,000
e.What are the differential cash flows over the project’s life?
Year 1Year 2Year 3Year 4Year 5
EBIT$8,200,000 $14,200,000 $16,600,000 $9,400,000 $4,800,000 Less: Taxes($2,788,000)($4,828,000)($5,644,000)($3,196,000)($1,632,000) Plus: Depreciation$1,600,000 $1,600,000 $1,600,000 $1,600,000 $1,600,000 Equals: Operating Cash Flow$7,012,000 $10,972,000 $12,556,000 $7,804,000 $4,768,000

...MiniCase Chapter 11
BUS 401 Principles of Finance
Lisa Parker
MiniCase 11 Chapter 11
I am aware that this is my new position as assistant financial analyst at Caledonia Products and that I am asked to consider the introduction of a new product into the company. My job will be to analyze the information you require in depth with research regarding my answer. Let it be known that I will have put every ounce of my knowledge into this assignment to make this experience one for the record books as an assistant analyst. Here, I have answers to your inquiries that I have personally thought of as a professional at my job.
Should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits?
On this particular take, I believe we should focus on free cash flows rather than profits because the company itself can receive cash flow and reinvest it. The benefit or cost of this can be determined in due time. We can analyze and come to the conclusion that we are only interested in the after tax basis of these cash flows because these are available to the shareholders. The next thing we are interested in is the incremental cash flows because for this project these incremental cash flows are the marginal benefits we are looking for as a whole....

...Capital Budgeting MiniCase
There are many different methods business owners use to efficiently analyze business investment. One of these effective methods is the calculation of the net present value or NPV. The second most effective method would be the calculations of the internal rate of return or IRR. There are also other useful methods as well, for example, the payback rule and the profitability index. Many business owners use the above procedures to help them in their decision making of acquiring other businesses.
“NVP is important to a project because if the cost of the investment is going to be, or is more than the revenue from that project, then it may be more cost effective to shut down the project all together rather than lose more money. If multiple projects are available, then it is wise to first calculate the NPV for each project, choose those that have a positive NPV, and reject the ones that have zero or negative NPVs. Moreover, the IRR method can be used, and generally, they should provide the same ranking of the projects because the projects with high NPV also tend to have high IRR (Hestwood, Lial, Hornsby, & McGinnis 2010)”.
“There are many reasons the IRR is imperative to a company. If the rate of return is insufficient, it means additional cash is out flowing from the company than is inflowing into the company. This could lead to negative working capital. The IRR is imperative for a company to understand, so if necessary,...

...MINI-CASE
A)
Answer: Capital budgeting is the process of analyzing additions to fixed assets. Capital budgeting is important because, more than anything else, fixed asset investment decisions chart a company's course for the future. Conceptually, the capital budgeting process is identical to the decision process used by individuals making investment decisions. These steps are involved:
1. Estimate, evaluate, & assess the riskiness of the cash flows
2. Determine the appropriate discount rate
B)
Answer: Projects are independent if the cash flows of one are not affected by the acceptance of the other. On the other hand, two projects are mutually exclusive if acceptance of one impacts adversely the cash flows of the other; that is, at most one of two or more such projects may be accepted.
C)
Answer 1: The net present value is the sum of the present values of a project's cash flows:
NPVs are easy to determine using a calculator with an NPV function. NPVL = $18.78 and NPVS = $19.98.
Answer 2: The rationale behind the NPV method is straightforward: if a project has NPV = $0, then the project generates exactly enough cash flows to recover the cost of the investment and to enable investors to earn their required rates of return (the opportunity cost of capital). If NPV = $0, then in a financial (but not an accounting) sense, the project breaks even. If the NPV is positive, then more than enough...

...( Answers to Mini-Case Questions
BioCom Inc.
This mini-case provides a review of the methodology and rationale associated with the various capital budgeting evaluation methods such as payback period, discounted payback period, NPV, IRR, MIRR,
and PI.
1. Compute the payback period for each project.
|Time of Cash Flow |Nano Test Tubes |Microsurgery Kit |
|Investment |−$11,000.00 |−$11,000.00 |
|Year 1 | 2,000.00 | 4,000.00 |
|Year 2 | 3,000.00 | 4,000.00 |
|Year 3 | 4,000.00 | 4,000.00 |
|Year 4 | 5,000.00 | 4,000.00 |
|Year 5 | 7,000.00 | 4,000.00 |
Payback for Nano: cash flows for the first three years total $9,000. (11,000 − 9,000)/4,000 ’ .5, so payback for Nano is 3.5 years. For Microsurgery: cash flows for the first two years total $8,000.
(11,000 − 8,000)/4,000 ’ 0.75, so payback for Microsurgery is 2.75 years.
a. Explain the rationale behind the payback method.
The payback simply computes the break-even point for a project in...

...MiniCase Chapter 11
a. What is capital budgeting?
Capital budgeting is the decision process that managers use to identify those projects that add value to the firm’s value, and as such it is perhaps the most important task faced by financial managers and their staff. The process of evaluating projects is critical for a firm’s success. Capital budgeting is
• Analysis of potential additions to fixed assets
• Long term decisions; involving large expenditures
• Very important to a firm’s future
• Define the firm’s strategic directions
b. What is the difference between independent and mutually exclusive projects?
An independent project is one in which accepting or rejecting one project does not affect the acceptance or rejection of other projects under consideration. No relationship exists between the cash flows of one project and another. A mutually exclusive projects is one in which the acceptance of one exclude the acceptance of other projects
c. c. 1. Define the term net present value (NPV).
The net present value is based upon the discounted cash flow technique. To implement this approach find the present value of each cash flow, including the initial cash flow, discounted at the project’s cost of capital, r. Sum these discounted cash flows; this sum is defined as the project’s NPV.
c.1b. What is each franchise's NPV?
|Expected Net Cash Flow...

...6/14/2003
Chapter 11 MiniCase
Situation Shrieves Casting Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by Sidney Johnson, a recently graduated MBA. The production line would be set up in unused space in Shrieves' main plant. The machinery’s invoice price would be approximately $200,000; another $10,000 in shipping charges would be required; and it would cost an additional $30,000 to install the equipment. The machinery has an economic life of 4 years, and Shrieves has obtained a special tax ruling which places the equipment in the MACRS 3-year class. The machinery is expected to have a salvage value of $25,000 after 4 years of use. The new line would generate incremental sales of 1,250 units per year for four years at an incremental cost of $100 per unit in the first year, excluding depreciation. Each unit can be sold for $200 in the first year. The sales price and cost are expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm’s net operating working capital would have to increase by an amount equal to 12% of sales revenues. The firm’s tax rate is 40 percent, and its overall weighted average cost of capital is 10 percent. a. Define “incremental cash flow.” Answer: See Chapter 11 MiniCase Show (1.) Should you subtract interest expense or dividends when calculating project cash flow? Answer: See Chapter...

...MiniCase Report – The Dilemma at Day-Pro
1) PayBack Period for Synthetic Resin and Epoxy Resin:
Synthetic Resin PBP = 2 + 250/200 = 2.5 years
Epoxy Resin PBP = 1 + 200/400 = 1.5 years
To show that using the Payback Period to evaluate the projects is flawed, Tim can argue that the PayBack Period ignores the time value of money, requires an arbitrary cutoff point, ignores cash flows beyond the cutoff date, and is biased against long-term projects, such as research and development, and new projects (Corporate Finance page 238).
2) Discounted payback Period (DPP) using 10% discount rate:
Synthetic Resin DPP:
{1,000,000 – [(350,000)/(1 + 0.1)^1 + (400,000)/(1+0.1)^2]} x 100 = 35,124,100/375,657 = 93.5% of year 3
1 + 1 +0.935 =2.935
Epoxy Resin DPP:
{800,000 – [(600,000)/(1 + 0.1)^1]} x 100 = (800,000 – 545,454.5) x 100 = 25,454,550/330,578.5 = 77% of year 2.
1 +0.77= 1.77
Tim should not ask the Board to use DPP as the deciding factor because DPP does not provide a concrete decision criterion that can indicate whether the investment will increase the firm's value, it requires an estimate of the cost of capital in order to calculate the payback, and it ignores cash flows beyond the discounted payback period.
4) Synthetic Resin IRR = 37%
Epoxy Resin IRR = 43%
IRR calculated using Excel
Tim can convince the board that IRR measure can be misleading by explaining that it may result in multiple answers with...

...Quiz chapter 2
1. __________ refers to the change in the firm's current assets relative to its current liabilities over some time period.
A) Operating cash flow
B) Capital spending
C) Cash flow to creditors
D) Cash flow from assets
E) Additions to net working capital
2. If total assets = $550, fixed assets = $375, current liabilities = $140, equity = $265, long term debt = $145, and current assets is the only remaining item on the balance sheet, what is the value of net working capital?
A) -$265
B) $230
C) $190
D) $35
E) $265
3. Which of the following is NOT typically characterized as a current asset?
A) Inventory
B) Cash on hand
C) Patents
D) Accounts receivable
E) Marketable securities
4. Under GAAP, balance sheet assets are
A) only carried on the books if they are relatively liquid
B) carried on the books at historic cost
C) carried on the books at market value
D) listed in order of increasing relative liquidity
E) carried at the larger of historic cost and market value
5. Which of the following accurately describes the relation between book and market value?
A) Financial managers should rely on book values, and not market values, when making decisions for the firm, because the firm's tax liability is based on book values.
B) Financial managers should rely on market values, and not book values, when making decisions for the firm, because the firm's tax liability is based on market...

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