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.
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.
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 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
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
• 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 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 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 External Economic & Political Data
• Business Cycle Stages
• Inflation Trends
• Interest Rate Trends
• Interest Rate Trends
• Exchange Rate Trends
• Freedom of Cross-Border Currency Flows
• Political Stability
• Regulations
• Taxation
Internal Financial Data Internal Financial Data
• Initial Outlay & Working Capital
• Estimated Cash Flows
• Financing Costs
• Financing Costs
• Transportation, Shipping and Installation Costs
• Competitor Information
Non
Non--Financial Data Financial Data
• Distribution Channels
• Labor Force Information
• Labor-Management Relations
• 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 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) (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
• 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
depreciation charges of $ 200 in
particular year. Tax rate 35%.
Income Statement
Revenues
Revenues $ 1,000 $ 1,000
Cash expenses
Cash expenses 600 600
Depreciation expenses
Depreciation expenses 200 200
Depreciation expenses
Depreciation expenses 200 200
Profit before tax
Profit before tax 200 200
Tax at 35%
Tax at 35% 70 70
Net profit
Net profit 130 130
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
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
Pendapatan Rp 75.000.000,00 Rp 75.000.000,00 Beban tunai
Beban tunai Rp 30.000.000,00 Rp 30.000.000,00 Depresiasi
Depresiasi Rp 25.000.000,00 Rp 25.000.000,00 Laba sebelum
Laba sebelum Rp 20.000.000,00 Rp 20.000.000,00 Laba sebelum
Laba sebelum pajak
pajak
Rp 20.000.000,00 Rp 20.000.000,00 Pajak
Pajak Rp 5.000.000,00 Rp 5.000.000,00 Laba setelah
Laba setelah pajak
pajak
Rp 15.000.000,00
Rp 15.000.000,00
Jika investasi tersebut akan didanai oleh modal pinjaman dengan tingkat bunga 15% per tahun.
Laporan Rugi Laba sbb:
Pendapatan
Pendapatan Rp 75.000.000,00 Rp 75.000.000,00 Beban tunai
Beban tunai Rp 30.000.000,00 Rp 30.000.000,00 Depresiasi
Depresiasi Rp 25.000.000,00 Rp 25.000.000,00 Depresiasi
Depresiasi Rp 25.000.000,00 Rp 25.000.000,00 Laba sebelum bunga dan pajak
Laba sebelum bunga dan pajak Rp 20.000.000,00 Rp 20.000.000,00 Bunga
Bunga Rp 15.000.000,00 Rp 15.000.000,00 Laba sebelum pajak
Laba sebelum pajak Rp 5.000.000,00 Rp 5.000.000,00 Pajak
Pajak Rp 1.250.000,00 Rp 1.250.000,00 Laba setelah pajak
Laba setelah pajak Rp 3.750.000,00 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
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
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 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 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
Bangunan (Rp)
Bangunan (Rp) Peralatan (Rp) Peralatan (Rp) Nilai jual
Nilai jual 20.000.000 20.000.000 10.000.000 10.000.000 Nilai buku
Nilai buku 00 00
Nilai buku
Nilai buku 00 00
Gain on sales of Gain on sales of Assets
Assets 20.000.000 20.000.000 10.000.000 10.000.000 Pajak
Pajak 8.000.000 8.000.000 4.000.000 4.000.000 Arus kas
Arus kas 12.000.000 12.000.000 6.000.000 6.000.000
Laporan Rugi Laba
Hasil penjualan
Hasil penjualan Rp 600.000.000,00 Rp 600.000.000,00 Biaya variabel
Biaya variabel 420.000.000,00 420.000.000,00 Biaya tetap
Biaya tetap 80.000.000,00 80.000.000,00 Depresiasi bangunan
Depresiasi bangunan 30.000.000,00 30.000.000,00 Depresiasi bangunan
Depresiasi bangunan 30.000.000,00 30.000.000,00 Depresiasi peralatan
Depresiasi peralatan 20.000.000,00 20.000.000,00 550.000.000,00 550.000.000,00 Laba sebelum pajak
Laba sebelum pajak 50.000.000,00 50.000.000,00 Pajak , 40%
Pajak , 40% 20.000.000,00 20.000.000,00 Laba setelah pajak
Laba setelah pajak 30.000.000,00 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
• 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
• 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.
at 5% a year.
• Equipment can be sold at the end of the
project $ 2,000,000
Revenues & A/R (in 000 )
Year
Year Revenues Revenues A/R A/R 0
0 1
1 $ 15,000 $ 15,000 $ 2,500 $ 2,500 1
1 $ 15,000 $ 15,000 $ 2,500 $ 2,500 2
2 $ 15,750 $ 15,750 2,625 2,625 3
3 $ 16,538 $ 16,538 2,756 2,756 4
4 $ 17,364 $ 17,364 2,894 2,894 5
5 $ 18,233 $ 18,233 3,039 3,039
Expenses & Inventory ( in 000 )
Year
Year Expenses Expenses Inventory Inventory 0
0 $ 1,500 $ 1,500
1
1 $ 10,000 $ 10,000 $ 1,575 $ 1,575 1
1 $ 10,000 $ 10,000 $ 1,575 $ 1,575 2
2 $ 10,500 $ 10,500 $ 1,654 $ 1,654 3
3 $ 11,025 $ 11,025 $ 1,736 $ 1,736 4
4 $ 11,576 $ 11,576 $ 1,823 $ 1,823 5
5 $ 12,155 $ 12,155
A/R,Inventory & WC
Year
Year A/R A/R Inventory Inventory WC WC 0
0 $ 1,500 $ 1,500 $ 1,500 $ 1,500 1
1 $ 2,500 $ 2,500 $ 1,575 $ 1,575 $ 4,075 $ 4,075 1
1 $ 2,500 $ 2,500 $ 1,575 $ 1,575 $ 4,075 $ 4,075 2
2 2,625 2,625 $ 1,654 $ 1,654 $ 4,279 $ 4,279 3
3 2,756 2,756 $ 1,736 $ 1,736 $ 4,493 $ 4,493 4
4 2,894 2,894 $ 1,823 $ 1,823 $ 4,717 $ 4,717 5
5 3,039 3,039 $ 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
1 2 2 3 3 4 4 5 5
Revenues
Revenues $ 15,000 $ 15,000 $ 15,750 $ 15,750 $ 16,538 $ 16,538 $ 17,364 $ 17,364 18,233 18,233 Expenses
Expenses 10,000 10,000 $ 10,500 $ 10,500 $ 11,025 $ 11,025 $ 11,576 $ 11,576 12,155 12,155 Depr
Depr 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 Profit
Profit
before tax before tax
3,000
3,000 3,250 3,250 3,513 3,513 3,788 3,788 4,078 4,078 Tax
Tax 1,050 1,050 1,138 1,138 1,229 1,229 1,326 1,326 1,427 1,427 Profit after
Profit after tax
tax
1,950
1,950 2,113 2,113 2,284 2,284 2,462 2,462 2,651 2,651
Cash Flow ( in 000 )
0
0 1 1 2 2 3 3 4 4 5 5 6 6
Initial Initial Cash Cash flow flow
--$10,000 $10,000
Salvage
Salvage $ 1,300 $ 1,300
Salvage Salvage value value
$ 1,300
$ 1,300
Investm Investm ent in ent in Working Working capital capital
-- $ 1,500 $ 1,500 -- $ 2,575 $ 2,575 -- $ 204 $ 204 -- $214 $214 -- $ 224 $ 224 $ 1,678 $ 1,678 $ 3,039 $ 3,039
Operatio Operatio nal
nal Cash Cash flow flow
$ 3,950
$ 3,950 $ 4,113 $ 4,113 $ 4,284 $ 4,284 $ 4,462 $ 4,462 $ 4,651 $ 4,651
Total
Total --$11,500 $11,500 1,375 1,375 3,909 3,909 4,070 4,070 4,238 4,238 6,329 6,329 4,339 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 5- year recovery period
• The replacement increase in current assets $
• 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 Revenue Expenses
1 $ 2,520,000 $ 2,300,000
2 $ 2,520,000 $ 2,300,000
3 $ 2,520,000 $ 2,300,000
3 $ 2,520,000 $ 2,300,000
4 $ 2,520,000 $ 2,300,000
5 $ 2,520,000 $ 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 using a 5-year recovery period
• Buyer willing to pay $ 280,000
• Revenue and expenses (excl. Depr & interest)
as follow:
Year
Year Revenues Revenues Expenses Expenses 1
1 $ 2,200,000 $ 2,200,000 $ 1,990,000 $ 1,990,000 2
2 $ 2,300,000 $ 2,300,000 $ 2,110,000 $ 2,110,000 3
3 $ 2,400,000 $ 2,400,000 $ 2,230,000 $ 2,230,000 3
3 $ 2,400,000 $ 2,400,000 $ 2,230,000 $ 2,230,000 4
4 $ 2,400,000 $ 2,400,000 $ 2,250,000 $ 2,250,000 5
5 $ 2,250,000 $ 2,250,000 $ 2,120,000 $ 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 – 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
Year Depreciation Depreciation percentage percentage
Depreciation Depreciation expenses
expenses 1
1 20% 20% $ 80,000 $ 80,000 2
2 32% 32% 128,000 128,000 2
2 32% 32% 128,000 128,000 3
3 19% 19% 76,000 76,000 4
4 12% 12% 48,000 48,000 5
5 12% 12% 48,000 48,000 6
6 5% 5% 20,000 20,000
Depreciation Expenses- Old Machine
Year
Year Depreciation Depreciation percentage percentage
Depreciation Depreciation Expenses
Expenses 1
1 12% 12% 28,800 28,800 2
2 12% 12% 28,800 28,800 3
3 5% 5% 12,000 12,000
4
4
5
5
6
6
Operating cash flow-New Machine
1
1 22 33 44 55 66
Revenue
Revenue $ 2,520,000$ 2,520,000 $ 2,520,000$ 2,520,000 $ 2,520,000$ 2,520,000 $ 2,520,000$ 2,520,000 $ 2,520,000$ 2,520,000
Expenses
Expenses 2,300,0002,300,000 2,300,0002,300,000 2,300,0002,300,000 2,300,0002,300,000 2,300,0002,300,000
Earning Earning before Depr, before Depr, Interest and Interest and Taxes
Taxes
220,000
220,000 220,000220,000 220,000220,000 220,000220,000 220,000220,000
Taxes Taxes
Depreciation
Depreciation 80,00080,000 128,000128,000 76,00076,000 48,00048,000 48,00048,000 20,00020,000
Earning Earning before before Interest and Interest and Taxes
Taxes
140,000
140,000 92,00092,000 144,000144,000 172,000172,000 172,000172,000 -- 20,00020,000
Taxes
Taxes 56,00056,000 36,80036,800 57,60057,600 68,80068,800 68,80068,800 --8,0008,000
Net operating Net operating profit after profit after taxes taxes
84,000
84,000 55,20055,200 86,40086,400 103,200103,200 103,200103,200 -- 12,00012,000
Depreciation
Depreciation 80,00080,000 128,000128,000 76,00076,000 48,00048,000 48,00048,000 20,00020,000
Cash flow
Cash flow 164,000164,000 183,200183,200 162,400162,400 151,200151,200 151,200151,200 8,0008,000
Operating cash flow-Old Machine
1
1 22 33 44 55 66
Revenue
Revenue $ 2,200,000$ 2,200,000 $ 2,300,000$ 2,300,000 $ 2,400,000$ 2,400,000 $ 2,400,000$ 2,400,000 $ 2,250,000$ 2,250,000
Expenses
Expenses 1,990,0001,990,000 2,110,0002,110,000 2,230,0002,230,000 2,250,0002,250,000 2,120,0002,120,000
Earning Earning before Depr, before Depr, Interest and Interest and Taxes
Taxes
210,000
210,000 190,000190,000 170,000170,000 150,000150,000 130,000130,000
Taxes Taxes
Depreciation
Depreciation 28,80028,800 28,80028,800 12,00012,000
Earning Earning before before Interest and Interest and Taxes
Taxes
181,200
181,200 161,200161,200 158,000158,000 150,000150,000 130,000130,000
Taxes
Taxes 72,48072,480 64,48064,480 63,20063,200 60,00060,000 52,00052,000
Net operating Net operating profit after profit after taxes taxes
108,720
108,720 96,72096,720 94,80094,800 90,00090,000 78,00078,000
Depreciation
Depreciation 28,80028,800 28,80028,800 12,00012,000
Cash flow
Cash flow 137,520137,520 125,520125,520 106,800106,800 90,00090,000 78,00078,000
