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Capital Budgeting

 Self-Paced Overview

Net Cash Flows

Example 2:

You have the following information available: Company is in 30% tax rate.

Estimated Earnings:

  Without
New Project
With
New Project
1 $100,000 $175,000
2 $120,000 $185,000
3 $140,000 $150,000

Depreciation:

  Without
New Project
With
New Project
1 $10,000 $50,000
2 $10,000 $60,000
3 $10,000 $70,000

In this case, you have to figure the differences in projected earnings and depreciation with and without the new project. What you're interested in is the incremental effect of the new project.

Estimated Earnings:

  Without
New Project
With
New Project
Difference
1 $100,000 $175,000 $75,000
2 $120,000 $185,000 $65,000
3 $140,000 $150,000 $10,000

Depreciation:

  Without
New Project
With
New Project
Difference
1 $10,000 $50,000 $40,000
2 $10,000 $60,000 $50,000
3 $10,000 $70,000 $60,000

NOTE: There's probably no depreciation technique where we could get a depreciation schedule like this. This is just for purposes of illustration.

Yr ΔEBTD ΔDEPR = ΔEBT(1−t) = EAT + ΔDEPR = NCF
1 $75,000 $40,000 = $35,000(.7) = $24,500 + $40,000 = $64,500
2 $65,000 $50,000 = $15,000(.7) = $10,500 + $50,000 = $60,500
3 $10,000 $60,000 = −$50,000(.7) = −$35,000 + $60,000 = $25,000

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