Chapter 6 - Section 2
The Baldwin Company: An Example
Because capital budgeting requires numerous repetitive cash flows, it is an ideal application for Excel. When doing a
no calculations on your own, but rather let Excel do the calculations for you. We will begin with the Baldwin Compan
Year 1 Year 2 Year 3
Units sold per year: 5,000 8,000 12,000
Price per unit for Year 1: $ 20.00
Price increase per year: 2%
Inflation rate: 5%
Tax rate: 21%
Unit production cost for Year 1: $ 10.00
Increase in unit cost per year: 10%
NWC to start project: $ 10,000
NWC for subsequent years (as % of sales): 10%
Depreciation rate: 20.00% 32.00% 19.20%
Cost of machine $ 100,000
Cost of warehouse: $ 150,000
Pretax salvage value: $ 30,000
We will start off with some preliminary work, including the depreciation each year, sales price, and unit costs:
Year 1 Year 2 Year 3
Depreciation
Accumulated depreciation
Adjusted basis of machine
Price per unit
Sales revenue
Cost per unit
Operating costs
The change in net working capital for each year is the beginning net working capital for each year minus the net wor
working capital each year is:
Net working capital
Beginning NWC
End of year NWC
NWC cash flow
The machine will have a salvage value at the end of the project, but we are concerned with the aftertax salvage valu
Pretax salvage value
Taxes on sale
Aftertax salvage value
Now we can calculate the pro forma income statement for each year (Table 6.1), which will be:
Sales revenue
Operating costs
Depreciation
Income before taxes
Taxes at 21%
Net income
With this, the incremental cash flows each year, NPV for different interest rates, and IRR for the project are (Table 6
Year 0 Year 1 Year 2
Sales revenue
Operating costs
Taxes
Cash flow from operations
Bowling ball machine
Warehouse
Net working capital
Total cash flow of project
NPV
4%
10%
15%
20%
or Excel. When doing a capital budgeting problem, as in most Excel uses, you should do few or
th the Baldwin Company project. We have the following projections for the project:
Year 4 Year 5
10,000 6,000
11.52% 11.52%
e, and unit costs:
Year 4 Year 5
year minus the net working capital investment at the end of the year. So, the change in net
e aftertax salvage value, which is:
e:
he project are (Table 6.4):
Year 3 Year 4 Year 5
Initial Cost 80000
Dep 16000 16000 16000 16000 16000
Reduction in cost 22000 22000 22000 22000 22000
tax rate 21%
pre tax Salvage value 20000
discount rate 0.1
Year 0 1 2 3 4 5
Cash flow from Investing -80000 15800
Incremental change in EBT 6000 6000 6000 6000 6000
Incremental change in Tax expense 1260 1260 1260 1260 1260
add dep 16000 16000 16000 16000 16000
Cash flow from operation 20740 20740 20740 20740 20740
Net cash flow -80000 20740 20740 20740 20740 36540
NPV ₹ 8,431.47
Price per truck 25709.2418268596 (Assume)
Number of truck 5
Cost of platform 10000
Other cost per truck 4000
lease cost 24000
Fixed investment 60,000
salvage value 5,000
tax rate 0.21
discount rate 0.20
Performa Income statement
0 1 2 3 4
Revenue 128546.2 128546.2 128546.2 128546.2
cost 94000 94000 94000 94000
Dep 15000 15000 15000 15000
EBT 19546.21 19546.21 19546.21 19546.21
Tax 4104.704 4104.704 4104.704 4104.704
Change in working capital 40000 -40000
Operating cash flow -40000 30441.51 30441.51 30441.51 70441.51
Investing cash flow -60,000 3,950
Total Cash flow -100,000 30,442 30,442 30,442 74,392
NPV 0.0000000000
Discount rate 0.06
Year 0.00 1.00 2.00 3.00
Machine A -15.00 -5.00 -5.00 -5.00 -28.37
Machine B -10.00 -6.00 -6.00 -21.00
Machine A
Machine B
Chapter 6 - Section 5
Inflation and Capital Budgeting
Inflation should always be considered in any long-term project. As long as inflation is correctly handled, the NPV of t
projected proposed by Altshuler, Inc.
Example 6.11: Real and Nominal NPV
Altshuler, Inc. has generated the following forecast for a capital budgeting project. David Altshuler prefers to work i
Whose approach is correct?
Year 0 Year 1 Year 2
Capital expenditures: $ 1,210
Revenues (real terms): $ 1,900 $ 2,000
Cash expenses (real terms): 950 1,000
Depreciation: 605 605
Inflation rate: 10.0%
Nominal rate: 15.5%
Real rate: 5.0%
Tax rate: 21.0%
With these projections, we can generate the following nominal cash flows and NPV:
Nominal Cash Flows
Year 0 Year 1 Year 2
Capital expenditures
Revenues
Expenses
Depreciation
Taxable income
Taxes (21%)
Income after taxes
Depreciation
Cash flow
NPV @ 15.5%
We can also use real cash flows, which will be:
Real Cash Flows
Year 0 Year 1 Year 2
Capital expenditures
Revenues
Expenses
Depreciation
Taxable income
Taxes (21%)
Income after taxes
Depreciation
Cash flow
NPV @ 5%
When dealing with any cash flows, it is irrelevant whether you use real cash flows with the real interest rate or nom
value will always be the same.
n is correctly handled, the NPV of the project will be the same. For example, consider the
t. David Altshuler prefers to work in nominal terms, while Stuart Weiss prefers real cash flows.
PV:
with the real interest rate or nominal cash flows with the nominal interest rate, the present
