Baldwin

Topics: Generally Accepted Accounting Principles, Cash flow, Taxation in the United States Pages: 32 (1925 words) Published: February 27, 2014
Investment Policy
y
Baldwin Case: Practice

Corporate Finance
Hong Kong University of Science & Technology
Instructor: Peter MacKay

Baldwin C
B ld i Company (Chapter 8)
(Ch t
New line of bright-colored bowling balls.
Ran a $250,000 test market study last year.
$250 000 test-market
year
Would use a vacant $150,000 warehouse.
$ ,
Cost of bowling ball machine is $100,000.
Its salvage value ≈ $30,000 in year 5.
Price h ld
P i should grow 2% each of 5 years.
h f
Costs should grow 10% each of 5 years.
2

Baldwin: Pl
B ld i Plan of Analysis
fA l i
Identify th l
Id tif the relevant cash flows related to:
t
h fl
l t dt
F
FCF

Capital Expenditures (CAPEX)
Change in Net Working Capital (∆NWC)
Operating Cash Flow (income statements)

Discount each year’s free cash flow (FCF)
Find
Fi d NPV b summing di
by
i discounted FCFs
t d FCF
Accept or reject the project
3

Baldwin:
B ld i CAPEX & ∆NWC
1

2
3
4
5
6

Incremental Cash Flows
Capital Spending:
Test marketing study (sunk cost)
Bowling ball machine
Depreciation rate (IRS not FASB)
Fiscal depreciation (also in income)
Accumulated fiscal depreciation
Non-depreciated value (tax basis)
Tax owed by/to Baldwin on disposal
Routine
R i machine maintenance
hi
i
Warehouse (opportunity cost)
Total Capital Spending Cash Flow:
Change in Net Working Capital:

7 Total Investment Cash Flows:

Year:

0

250

1

n/a
-100

20.0%
20.00
20.00
80.00
34%
0.00
0.00
0 00
-150
0.00
0.00
1+2+3+4 -250
-10
10
0.00
0 00
5+6

-260

0.00

2

32.0%
32.00
52.00
48.00
0.00
0.00
0 00
0.00
0.00
-6.32
6 32

3

19.2%
19.20
71.20
28.80
0.00
0.00
0 00
0.00
0.00
-8.65
8 65

-6.32 -8.65

4

5

11.5%
11.52
82.72
17.28
0.00
0.00
0 00
0.00
0.00
3.75
3 75

30.00
11.5%
11.52
94.24
5.76
-8.24
0.00
0 00
150.00
171.76
21.22
21 22

3.75 192.98

4

Baldwin:
B ld i CAPEX & ∆NWC
1

2
3
4
5
6
7

Incremental Cash Flows
Year:
0
1
2
3
4
5
Capital Spending:
Test marketing study (sunk cost)
250
n/a
Bowling ball machine
-100
30.00
This is a sunk cost in that the study has already been conducted Depreciation rate (IRS not FASB)
20.0% 32.0% 19.2% 11.5% 11.5%
and paid. Although the intelligence the study generated is 11.52 11.52 Fiscal depreciation (also in income)
20.00 32.00 19.20 critical
71.20 82.72
in valuing fiscal depreciation j
i Accumulatedthe current project, the cost incurred 52.00 the study is 94.24 l i
h
h
i 20.00d for h
f
d i
Non-depreciated value (tax basis)
80.00
not directly recoverable (other 34% through the48.00 28.80 17.28 -8.24 than
value0.00 0.00 5.76
possibly
Tax owed by/to Baldwin on disposal
0.00 0.00
created in thei current
Routine
R i machine maintenance project – produce the balls) 00 0 00 0 00 0 00 hi
0.00 0
0 balls). This sunk cost
00 0.00 0.00 0.00 0.00
Warehouse (opportunity cost) cash flow and it is therefore irrelevant for -150
0.00 0.00 0.00 0.00 150.00
is not an incremental
Total Capital Spending Cash Flow:
0.00 0.00 0.00
1+2+3+4 -250
the current project. The cost was relevant at 00 -6.32 -8.65 30.00 171.76 p j Capital:
the time Baldwin 21.22
Change in Net Working
-10
10
0.00 6 32 8 65 3.75 21 22
0
75

was considering whether to commission the study. Now it is
Total Investment Cash Flows:
-260
0.00 -6.32 -8.65 3.75 192.98
5+6
spilled milk.

5

Baldwin:
B ld i CAPEX & ∆NWC
1

2
3
4
5
6

Incremental Cash Flows
Year:
0
1
2
3
4
5
Capital Spending:
Test marketing study (sunk cost)
250
n/a
Bowling ball machine
-100
30.00
Depreciation rate (IRS not FASB)
Assumes the machine is sold at the end of20.0% 32.0% 19.2% 11.5% 11.5% year 5 for $30. Any
Fiscal depreciation (also
20.00 32.00 19.20 11.52
difference betweenin income)
the salvage value and the non depreciated 11.52
non-depreciated
Accumulated fiscal depreciation
20.00 52.00 71.20 82.72...
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