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Chapter 24: Capital budgeting and cash flow - Coggle Diagram
Chapter 24: Capital budgeting and cash flow
Motives for capital expenditure
Renewal: renewing assets is an alt for replacement, offers a way to increase efficiency may find that replacing or renewing existing machinery to a optimal solution, the choice between the 2 comes down to the overall cost.
Expansion:
expanding the level of operations is the most common motive for capital expenditure and is usually achieved by acquiring non-current assets
Replacement:
in mature business the company must replace certain assets, as machines have to frequently get repairs the company must evaluate the assets in order to see if the need to be replaced.
Applying the Capital budgeting process(5 Steps):
Proposal generation;
all members of firm can make proposal for capital expenditure
Review and analysis;
The proprosal are reviewed to see if their relevant and aligned with the firms objectives and plans can be assessed by their economic viability.
Decision making;
seeing the amount required to achieve the agreed on decision.
Implementation;
Once the proposal verified and the funds are present comes the implementing of the plan, small decisions are pay'd off the larger ones must be monitored and bugdeted
Control;
Monitoring the results of the project, the feedback from the project can help compare the outcomes in respect of costs and benefits with those expected and those previous projects
2 types of projects
Indie projects, don't interfere with the other projects those which can meet the minimum investment criteria can be implemented
Mutually exclusive; projects that serve the same function once one is considered the other projects are discarded
Types of cash flow:
Conventional cash flow pattern, is one that involves an initial investment, flowed by a series of inflows
Unconventional cash flow patterns, any pattern in which initial out flow is not followed by a series of inflows, due to cash outflow being over and above the initial investment during one of the years of following the initial outflow
Annuity vs mixed stream cash flows
Annuity is a stream of equal annual cash flows, patterns that fall out of the annuity are regarded as a mixed stream cash flows
Major cash flow components
Capital expenditures with conventional cash flow patterns often consist of:
an initial investment
Operating cash flows expected each year
a terminal cash flow
Expansion vs replacement cash flows
Expansion decision, the initial investment, operating cash inflow and the terminal inflow are the after-tax outflow and inflows associated the proposed capital expenditure
Replacement decision, the initial investment can be determined by - of any after cash inflows expected from the sale of the asset from the initial investment needed to acquire the new asset.
Operating cash inflows can be calculated by working out the difference between the operating the difference between the after-tax cash flows that are expected upon termination of the new and old assets
Initial investment
Cost of a new asset:
is the net cash outflow for acquiring the asset, usually entails acquiring a non-current asset at a particular price
if no installation costs are involved and the firm is not replacing an existing asset, the purchase price of the asset, is equal to the initial investment.
Installation costs:
installation costs are any added costs that require to put assets in operations
SARS allows businesses to add installation costs to purchase price of assets in order to determine their depreciable value, which is depreciated over a number of years.
Proceeds from the sale of an old asset:
in the case of a replacement decision, the proceeds from the sale of the existing asset are the net cash inflow it provides
costs incurred by removal of old asset must be -from the gross proceeds from the sale of the asset.
proceeds from the sale of an old asset reduce the firm's initial investment in the new asset
Book value(BV) Vs market value with regards to depreciation and taxes:
the calc is BV = installed cost of an asset - accumulated depreciation
when selling or replacing an asset it may be sold for either above, the actual book value or below
Change in net working capital:
net working capital is the amount the firms current assets exceed its current liabilities
Capital expenditure results in the increase in current assets and current liabilites greater increase in Current assets can be expected
increase in the investment in net working capital is regarded as an initial outflow associated with the project, if the change is negative in the net working capital, it would then be shown as an initial inflow associated with capital expenditure
equation for incremental cash inflow in instances in which the profit before depreciation and taxes, the depreciation and the firms marginal:
ICFt = [△PBDTt X (1 - T)] + [△Dt XT]
ICFt - incremental cash inflow in year t
△PBDTt- change in profit before depreciation and taxes in year t
△Dt - change in depreciation in year t
T is the firm's marginal tax rate