Long-Term Investment Decisions
1. Capital Budgeting Cash Flows 2. Capital Budgeting Techniques 3. Risk and Refinements in Capital Budgeting
• Gitman & Zutter (2012:390): Capital Budgeting is the process of evaluating and selecting long-term investments that are consistent with the firm’s goal of maximazing owners’ wealth. • Brigham & Houston (2007: 358): Capital budgeting is process of planning capital expenditures on assets whose cash flows are expected to extend beyond one year.
Capital expenditure vs Operating expenditure • Capital Expenditure is an outlay of funds by the firm that is expected to produce benefits over a period of time greater than 1 year. • Operating Expenditure is an outlay of funds by the firm resulting in benefits received within 1 year. Not all capital expenditures are made for fixed assets. An expenditure made for an advertising campaign may have long-term benefits.
The primary motives for making capital expenditures include: Gitman. • Expansion—increasing the productive capacity of the firm, usually through the acquisition of fixed assets. • Replacement—replacing existing assets with new or more advanced assets that provide the same function. • Renewal—rebuilding or overhauling existing assets to improve efficiency. • Other motives include expenditures for nontangible projects that improve a firm’s profitability, such as advertising, research and development, and product development. A firm may also be required by law to undertake pollution control and similar projects.
Brigham & Houston (2007: 359) Project classifications: 1. Replacement : needed to continue current operations 2. Replacement: cost reduction 3. Expansion of existing products or markets 4. Expansion into new products or markets 5. Safety and/or enviromental projects 6. Other
Capital Budgeting Cash Flows Management need to understand which cash flows are relevant in making decisions about proposals …..
The Capital Budgeting Process Gitman & Zutter (2012:390) 1. Proposal generation 2. Review and analysis 3. Decision making 4. Implementation 5. Follow-up
Basic Terminology: 1. Independent vs Mutually exclusive projects 2. Unlimited funds vs Capital rationing 3. Accept-Reject vs Ranking Approaches
Independent versus Mutually Exclusive Investments • Mutually Exclusive Projects are investments that compete in some way for a company’s resources. A firm can select one or another but not both. • Independent Projects, on the other hand, do not compete with the firm’s resources. A company can select one, or the other, or both -- so long as they meet minimum profitability thresholds.
Unlimited Funds Versus Capital Rationing Firms under capital rationing have only a fixed amount of dollars available for the capital budget, whereas a firm with unlimited funds may accept all projects with a specified rate of return. • If the firm has unlimited funds for making investments, then all independent projects that provide returns greater than some specified level can be accepted and implemented.
Accept-reject versus ranking approaches: • The accept-reject approach involves evaluating capital expenditure proposals to determine whether they meet the firm’s minimum acceptance criterion. • The ranking approach, involves ranking projects on the basis of some predetermined measure, such as rate of return.
The Pattern of Cash Flows • Most projects have a conventional pattern of cash flows (-,+,+,+,+,+,+). • Some may have unconventional cash flows (-,-,+,+,,+,-,+). • For projects with unconventional cash flows, we may have the problem of multiple IRRs.
Categories of Cash Flows: – Initial Cash Flows are cash flows resulting initially from the project. These are typically net negative outflows. – Operating/Operational Cash Flows are the cash flows generated by the project during its operation. These cash flows typically net positive cash flows. – Terminal Cash Flows result from the disposition of the project. These are typically positive net cash flows.
Initial cashflow: aliran kas yang berhubungan dengan pengeluaran-pengeluaran kas untuk keperluan investasi. Termasuk dalam initial cashflow adalah kebutuhan dana yang digunakan untuk modal kerja. Operational cashflow: aliran kas yang akan digunakan untuk menutup investasi, yang diterima setiap tahun selama umur investasi, dan berupa aliran kas bersih. Terminal cashflow : aliran kas yang diterima pada akhir umur investasi. Dapat berupa nilai residu (taksiran nilai jual aktiva tetap pada akhir umur investasi) dan modal kerja.
Data & Information Requirements External Economic & Political Data • Business Cycle Stages • Inflation Trends • Interest Rate Trends • Exchange Rate Trends • Freedom of Cross-Border Currency Flows • Political Stability • Regulations • Taxation
Internal Financial Data • Initial Outlay & Working Capital • Estimated Cash Flows • Financing Costs • Transportation, Shipping and Installation Costs • Competitor Information
Non-Financial Data Non• Distribution Channels • Labor Force Information • Labor-Management Relations • Status of Technological Change in the Industry • Competitive Analysis of the Industry • Potential Competitive Reactions
Irrelevant Cash Flows • Sunk Costs are not relevant to the analysis because these costs are not dependent on whether or not the project is undertaken. One example would be to include the cost of land already purchased as part of the decision as to how to develop it. • Financing costs are not relevant to the determination of cash flows only because they are already accounted for through the discounting process.
Finding the Initial Investment: a. The cost of the new asset is the purchase price. (Outflow) b. Installation costs are any added costs necessary to get an asset into operation. (Outflow) c. Proceeds from sale of old asset are cash inflows resulting from the sale of an existing asset, reduced by any removal costs. (Inflow) d. Tax on sale of old asset is incurred when the replaced asset is sold due to recaptured depreciation, capital gain, or capital loss. (May be an inflow or an outflow) e. The change in net working capital is the difference between the change in current assets and the change in current liabilities. (May be an inflow or an outflow)
Change in Net Working Capital: • Net working capital is the amount by which a firm’s current assets exceed its current liabilities. • Change in net working capital is the difference between the change in current assets and the change in current liabilities.
Cash Flow from Operations: Profit After-tax + Depreciation + Interest ( 1- tax rate)
Exp 8.6: A project generates revenues of $ 1,000, cash expenses of $ 600, and depreciation charges of $ 200 in particular year. Tax rate 35%.
Income Statement Revenues
$ 1,000
Cash expenses
600
Depreciation expenses
200
Profit before tax
200
Tax at 35% Net profit
70 130
Penentuan Operational cashflow dengan berbagai sumber pendanaan Suatu investasi membutuhkan dana sebesar Rp 100.000.000,00 yang akan didanai oleh modal sendiri, dengan umur investasi 4 tahun, beban tunai Rp 30.000.000,00 per tahun dan pajak 25%. Depresiasi dengan metode garis lurus dan pendapatan per tahun Rp 75.000.000,00.
Laporan Rugi Laba Pendapatan Beban tunai
Rp 75.000.000,00 Rp 30.000.000,00
Depresiasi
Rp 25.000.000,00
Laba sebelum pajak Pajak
Rp 20.000.000,00
Laba setelah pajak
Rp 15.000.000,00
Rp 5.000.000,00
Jika investasi tersebut akan didanai oleh modal pinjaman dengan tingkat bunga 15% per tahun. Laporan Rugi Laba sbb: Pendapatan Beban tunai Depresiasi Laba sebelum bunga dan pajak Bunga Laba sebelum pajak Pajak Laba setelah pajak
Rp 75.000.000,00 Rp 30.000.000,00 Rp 25.000.000,00 Rp 20.000.000,00 Rp 15.000.000,00 Rp 5.000.000,00 Rp 1.250.000,00 Rp 3.750.000,00
Depreciation
Some Complexities • Inflation is typically adjusted for in the cash flow component of the calculation • Taxes are typically adjusted for in the cash flow calculation, yielding net after-tax cash flows • Risk is typically adjusted for in the discount rate portion of the calculation
Penentuan Arus Kas PT ABC menerima tawaran dari PT X yang ingin membeli produknya dan dituangkan dalam kontrak selama 4 tahun, yaitu mulai 2009 – 2012. Jumlah produk yang akan dibeli sebanyak 20.000 unit per tahun dengan harga jual Rp 30.000,00 per unit. Perusahaan harus menambah kapasitas produksinya, karena itu perusahaan akan menambah bangunan dan peralatan.
Perusahaan memperkirakan bangunan memerlukan biaya Rp 120.000.000,00 dan peralatan Rp 80.000.000,00. Selain itu perusahaan juga memerlukan tambahan modal kerja sebesar Rp 60.000.000,00. Biaya variabel per unit Rp 21.000,00 dan jumlah biaya tetap per tahun Rp 80.000.000,00.
• Tarif pajak 40%. • Depresiasi dengan metode garis lurus. Pada akhir tahun 2012 diharapkan bangunan dapat terjual dengan harga Rp 20.000.000,00 dan peralatan Rp 10.000.000,00. Depresiasi per tahun: • Bangunan Rp 30.000.000,00 • Peralatan Rp 20.000.000,00
Nilai jual Nilai buku
Bangunan (Rp)
Peralatan (Rp)
20.000.000
10.000.000
0
0
Gain on sales of Assets Pajak
20.000.000
10.000.000
8.000.000
4.000.000
Arus kas
12.000.000
6.000.000
Laporan Rugi Laba Hasil penjualan Biaya variabel Biaya tetap Depresiasi bangunan Depresiasi peralatan Laba sebelum pajak Pajak , 40% Laba setelah pajak
Rp 600.000.000,00 420.000.000,00 80.000.000,00 30.000.000,00 20.000.000,00 550.000.000,00 50.000.000,00 20.000.000,00 30.000.000,00
Arus Kas terdiri dari: • Investasi awal Rp 260.000.000,00 • Arus kas operasi Rp 80.000.000,00 per tahun selama 4 tahun • Arus kas terminal pada akhir tahun ke 4 sebesar Rp 78.000.000,00.
Bloopers Industries chapter 8: Brealey, Myers & Marcus • Investment of $ 10,000,000 in mining machinery, at the end of 5 years the ore deposit is exhaused • The company applies straight line depreciation • Tax 35% • A/R turn over 6 kali per tahun • Inventory = 15% dari expenses tahun berikutnya
• In year 1 revenue $ 15,000,000 and increase by 5% per year. • In year 1 expenses $ 10,000,000 and increase at 5% a year. • Equipment can be sold at the end of the project $ 2,000,000
Revenues & A/R (in 000 ) Year
Revenues
A/R
0 1
$ 15,000
$ 2,500
2
$ 15,750
2,625
3
$ 16,538
2,756
4
$ 17,364
2,894
5
$ 18,233
3,039
Expenses & Inventory ( in 000 ) Year
Expenses
0
Inventory $ 1,500
1
$ 10,000
$ 1,575
2
$ 10,500
$ 1,654
3
$ 11,025
$ 1,736
4
$ 11,576
$ 1,823
5
$ 12,155
A/R,Inventory & WC Year
A/R
0
Inventory
WC
$ 1,500
$ 1,500
1
$ 2,500
$ 1,575
$ 4,075
2
2,625
$ 1,654
$ 4,279
3
2,756
$ 1,736
$ 4,493
4
2,894
$ 1,823
$ 4,717
5
3,039
$ 3,039
• An increase in working capital is an investment, and therefore implies a negative cash flow; a decrease in working capital implies a positive cash flow. In years 1-4 the change is positive; in these years the project requires a continuing investment in working capital. In year 5 the change is negative; there is a disinvestment as working capital is recovered.
Income Statement 1
2
3
4
5
Revenues
$ 15,000
$ 15,750
$ 16,538
$ 17,364
18,233
Expenses
10,000
$ 10,500
$ 11,025
$ 11,576
12,155
Depr
2,000
2,000
2,000
2,000
2,000
Profit before tax
3,000
3,250
3,513
3,788
4,078
Tax
1,050
1,138
1,229
1,326
1,427
Profit after tax
1,950
2,113
2,284
2,462
2,651
Cash Flow ( in 000 ) 0 Initial Cash flow
1
2
3
4
5
-$10,000
Salvage value Investm ent in Working capital
$ 1,300
- $ 1,500
Operatio nal Cash flow Total
6
-$11,500
- $ 2,575
- $ 204
- $214
- $ 224
$ 1,678
$ 3,950
$ 4,113
$ 4,284
$ 4,462
$ 4,651
1,375
3,909
4,070
4,238
6,329
$ 3,039
4,339
Powell corporation Chapter 11: Gitman & Zutter New Machine: • Purchase price $ 380,000 , installation costs $ 20,000, to be depreciated under MACRS using a 5year recovery period • The replacement increase in current assets $ 35,000 and increase in current liabilities $ 18,000 increase in working capital $ 17,000 • Tax rate 40% • Revenue and expenses (excl. Depr & interest) as follow:
Year 1 2 3 4 5
Revenue $ 2,520,000 $ 2,520,000 $ 2,520,000 $ 2,520,000 $ 2,520,000
Expenses $ 2,300,000 $ 2,300,000 $ 2,300,000 $ 2,300,000 $ 2,300,000
Old Machine: • Was purchase 3 years ago at a cost $ 240,000 and was being depreciation under MACRS using a 5-year recovery period • Buyer willing to pay $ 280,000 • Revenue and expenses (excl. Depr & interest) as follow:
Year 1 2 3 4 5
Revenues $ 2,200,000 $ 2,300,000 $ 2,400,000 $ 2,400,000 $ 2,250,000
Expenses $ 1,990,000 $ 2,110,000 $ 2,230,000 $ 2,250,000 $ 2,120,000
After tax proceeds from sale of old machine: • Nilai jual $ 280,000 • Nilai buku 69,600 – Gain on sales 210,400 Pajak 40% 84,160 – $ 195,840
Initial Investment Cost of new machine: - Cost of machine $ 380,000 - Cost of installation 20,000 + $ 400,000 After tax proceeds from sale of old machine : - proceeds from sale of old machine $ 280,000 - Tax on sale of old machine 84,160 – $ 195,840 Change in working capital $ 17,000 + $ 221,160
Depreciation Expenses- New Machine Year Depreciation Depreciation percentage expenses 1 20% $ 80,000 2
32%
128,000
3
19%
76,000
4
12%
48,000
5
12%
48,000
6
5%
20,000
Depreciation Expenses- Old Machine Year 1
Depreciation percentage 12%
Depreciation Expenses 28,800
2
12%
28,800
3
5%
12,000
4 5 6
Operating cash flow-New Machine 1 Revenue
2
3
4
5
6
$ 2,520,000
$ 2,520,000
$ 2,520,000
$ 2,520,000
$ 2,520,000
2,300,000
2,300,000
2,300,000
2,300,000
2,300,000
Earning before Depr, Interest and Taxes
220,000
220,000
220,000
220,000
220,000
Depreciation
80,000
128,000
76,000
48,000
48,000
20,000
Earning before Interest and Taxes
140,000
92,000
144,000
172,000
172,000
- 20,000
Taxes
56,000
36,800
57,600
68,800
68,800
-8,000
Net operating profit after taxes
84,000
55,200
86,400
103,200
103,200
- 12,000
Depreciation
80,000
128,000
76,000
48,000
48,000
20,000
164,000
183,200
162,400
151,200
151,200
8,000
Expenses
Cash flow
Operating cash flow-Old Machine 1
Revenue
2
3
4
5
$ 2,200,000
$ 2,300,000
$ 2,400,000
$ 2,400,000
$ 2,250,000
1,990,000
2,110,000
2,230,000
2,250,000
2,120,000
Earning before Depr, Interest and Taxes
210,000
190,000
170,000
150,000
130,000
Depreciation
28,800
28,800
12,000
Earning before Interest and Taxes
181,200
161,200
158,000
150,000
130,000
72,480
64,480
63,200
60,000
52,000
Net operating profit after taxes
108,720
96,720
94,800
90,000
78,000
Depreciation
28,800
28,800
12,000
137,520
125,520
106,800
90,000
78,000
Expenses
Taxes
Cash flow
6
Incremental operating cash flow 1
New Machine Old Machine Cash Flow
2
3
4
5
$164,000 $183,200 $162,400 $151,200 $151,200
137,520
125,520
106,800
90,000
78,000
26,480
57,680
55,600
61,200
73,200
6
$ 8,000
8,000
Incremental operating cash flow: Δ EBDIT x ( 1 – t ) + (Δ D x t )
Terminal cash flow After tax proceeds from sale of new machine : - proceeds from sale of new machine $ 50,000 - Tax on sale of new machine 12,000 – $ 38,000 After tax proceeds from sale of old machine : - proceeds from sale of old machine $ 10,000 - Tax on sale of old machine 4,000 – $ 6,000 Change in working capital $ 17,000 + $ 49,000
Replacement Project • Intial cash flow $ 221,160 • Operating cash flow: 1 $ 26,480 2 57,680 3 55,600 4 61,200 5 73,200 • Terminal cash flow $ 49,000
