Model for Evaluating A New Capital Budgeting Project:

The first section of this worksheet contains a model for evaluating new projects. In Part 1, we first list the key inputs used in the calc
depreciation schedules for the building and for the equipment. Part 3 then determines the after-tax salvage values (i.e., net cash flow
the building and the equipment at the end of the project's life. Part 4 calculates the estimated cash flows over each year of the projec
estimated cash flows to estimate the key outputs, the project's NPV, IRR, MIRR, and Payback. Finally, we consider the riskiness of t
in the inputs result in changes in the key outputs.

Note that all dollars are shown in thousands; this is done for convenience.
Identifying the relevant cash flows

For a new project, the incremental cash flows can be divided into the following categories: initial investment outlay, operating cash f
project's life, and terminal year cash flows. The data used in the model were taken from an example. In addition to the input data, w
an excerpt from the MACRS Depreciation Schedule for 39-year (building) and 5-year (equipment) depreciation, and a table outlinin
'determination of net salvage values to be incorporated into our cash flow estimation.

Table 11-4. Analysis of a New (Expansion) Project

Part 1. Input Data (in thousands of dollars)
Building cost (= Depreciable basis)
Equipment cost (= Depreciable basis)
Net Operating WC / Sales
First year sales (in units)
Growth rate in units sold
Sales price per unit
Variable cost per unit
Fixed costs

$12,000
$8,000
10%
20,000
0.0%
$3.00
$2.10
$8,000

Market value of building in 2010

Market value of equip. in 2010
Tax rate
WACC
Inflation: growth in sales price
Inflation: growth in VC per unit
Inflation: growth in fixed costs

Part 2. Depreciation Schedule a

Years
1

Building Depr'n Rate

Building Depr'n
Ending Book Val: Cost - Cum. Depr'n

1.3%
$156
11,844

2.6%
$312
11,532

Equipment Depr'n Rate

Equipment Depr'n
Ending Book Val: Cost - Cum. Depr'n

20.0%
$1,600
6,400

32.0%
$2,560
3,840

The depreciation rates are multiplied by the depreciable basis ($12,000 for the building and $8,000 for the equipment) to determine the yearly dep
depreciation percentages for the building depend upon the month that the building is put in service. Because this analysis assumes that all cash flo
prevent unnecessary complexity, we have rounded the depreciation percentages for the building.

Part 3 of Table 11-4. Net Salvage Values in 2010

Estimated Market Value in 2010
Book Value in 2010b
Expected Gain or Lossc
Taxes paid or tax credit
Net cash flow from salvaged

Building
$7,500
10,908
-3,408
-1,363
$8,863

Equipment
$2,000
1,360
640
256
$1,744

Book value equals depreciable basis (initial cost in this case) minus accumulated MACRS depreciation. For the building, accumulated depreciati
$12,000 - $1,092 = $10,908. For the equipment, accumulated depreciation equals $6,640, so book value equals $8,000 - $6,640 = $1,360.

Building: $7,500 market value - $10,908 book value = -$3,408 a loss. This represents a shortfall in depreciation taken versus "true" depreciation,
expense for 2010. Equipment: $2,000 market value- $1,360 book value = $640 profit. Here the depreciation charge exceeds the "true" depreciati
"depreciation recapture". It is taxed as ordinary income in 2010. The actual book value at the time of disposition depends on the month of dispos
and assumed that there will be a full year of depreciation in 2010.

Net cash flow from salvage equals salvage (market) value minus taxes. For the building, the loss results in a tax credit, so net salvage value = $7,5

Part 4 of Table 11-4. Projected Net Cash

Flows (Time line of annual cash flows)
Investment Outlays: Long-Term Assets
Building
Equipment

Years
0
2006
($12,000)
(8,000)

Operating Cash Flows over the Project's Life

Units sold
Sales price
Sales revenue
Variable costs
Fixed operating costs
Depreciation (building)
Depreciation (equipment)
Oper. income before taxes (EBIT)
Taxes on operating income (40%)
Net Operating Profit After Taxes (NOPAT)
Add back depreciation
Operating cash flow
Cash Flows Due to Net Operating Working Capital
Net Operating Working Capital (based on sales)
Cash flow due to investment in NOWC
Salvage Cash Flows: Long-Term Assets
Net salvage cash flow: Building
Net salvage cash flow: Equipment

1
2007

20,000
$3.00
$60,000
42,000
8,000
156
1,600
8,244
3,298
4,946
1,756
$6,702

$6,000
($6,000)

$6,120
($120)

Total salvage cash flows

Net Cash Flow (Time line of cash flows)

($26,000)

Part 5 of Table 11-4. Key Output and Appraisal of the Proposed Project
Net Present Value (at 12%)
IRR
MIRR

$5,809
20.12%
17.79%

$6,582

st the key inputs used in the calculations. Part 2 goes on to calculate

alvage values (i.e., net cash flows) that will come from disposing of
ows over each year of the project's life. Part 5 then uses the
lly, we consider the riskiness of the project by showing how changes

estment outlay, operating cash flows over the

. In addition to the input data, we have included
epreciation, and a table outlining the

Key Output: NPV

$5,809

et value of building in 2010

et value of equip. in 2010

$7,500
$2,000
40%
12%
2.0%
2.0%
1.0%

on: growth in sales price

on: growth in VC per unit
on: growth in fixed costs
Years
3

Cumulative
Depr'n

4
2.6%
$312
11,220

2.6%
$312
$10,908

$1,092

19.0%
$1,520
2,320

12.0%
$960
$1,360

$6,640

pment) to determine the yearly depreciation expense. The correct

is analysis assumes that all cash flows occur at the end of the year, and to

-1000
Total

$10,607

e building, accumulated depreciation equals $1,092, so book value equals

8,000 - $6,640 = $1,360.

n taken versus "true" depreciation, and it is treated as an operating

harge exceeds the "true" depreciation, and the difference is called
on depends on the month of disposition. We have simplified the analysis

x credit, so net salvage value = $7,500 - (-$1,363) = $8,863.

Years
2
2008

3
2009

4
2010

20,000
$3.06
$61,200
42,840
8,080
312
2,560
7,408
2,963
4,445
2,872
$7,317

20,000
$3.12
$62,424
43,697
8,161
312
1,520
8,734
3,494
5,241
1,832
$7,073

20,000
$3.18
$63,672
44,571
8,242
312
960
9,587
3,835
5,752
1,272
$7,024

$6,242
($122)

$6,367
($125)

$0
$6,367

$8,863
1,744

42,000

42,840

$10,607
$7,194

$6,948

$23,999

200

300

COP1,636.82

43,697

44,571

400

600

800

Part 1. Input Data (in thousands of dollars)

Key Output: NPV

Building cost (= Depreciable basis)

Equipment cost (= Depreciable basis)
Net Operating WC / Sales
First year sales (in units)
Growth rate in units sold
Sales price per unit
Variable cost per unit
Fixed costs

Market value of building in 2010

Market value of equip. in 2010
Tax rate
WACC
Inflation: growth in sales price
Inflation: growth in VC per unit
Inflation: growth in fixed costs

Part 2. Depreciation Schedule a

Years
1

Building

Equipment

Building Depr'n Rate

Building Depr'n
Ending Book Val: Cost - Cum. Depr'n
Equipment Depr'n Rate
Equipment Depr'n
Ending Book Val: Cost - Cum. Depr'n

Part 3 of Table 11-4. Net Salvage Values in 2010

Estimated Market Value in 2010
Book Value in 2010b
Expected Gain or Lossc
Taxes paid or tax credit
Net cash flow from salvaged

Part 4 of Table 11-4. Projected Net Cash

Flows (Time line of annual cash flows)
Investment Outlays: Long-Term Assets
Building
Equipment
Operating Cash Flows over the Project's Life
Units sold
Sales price
Sales revenue
Variable costs
Fixed operating costs
Depreciation (building)

Years
0
2006

1
2007

Depreciation (equipment)
Oper. income before taxes (EBIT)
Taxes on operating income (40%)
Net Operating Profit After Taxes (NOPAT)
Add back depreciation
Operating cash flow
Cash Flows Due to Net Operating Working Capital
Net Operating Working Capital (based on sales)
Cash flow due to investment in NOWC
Salvage Cash Flows: Long-Term Assets
Net salvage cash flow: Building
Net salvage cash flow: Equipment
Total salvage cash flows
Net Cash Flow (Time line of cash flows)

Part 5 of Table 11-4. Key Output and Appraisal of the Proposed Project
Net Present Value (at 12%)
IRR
MIRR

utput: NPV

et value of building in 2010

et value of equip. in 2010

on: growth in sales price

on: growth in VC per unit
on: growth in fixed costs

Years
3

Cumulative
Depr'n

3
2009

4
2010

Total

Years
2
2008