Fundamentals of Corporate Finance Third edition Chapter 7 Using Brealey Myers Marcus Discounted Cash Flow ndamentals of Corporate Finan Analysis to Make Investment Decisions Brealey Myers Marcus slides by Matthew will IrwinMcGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 7- 1 Irwin/McGraw-Hill Chapter 7 Fundamentals of Corporate Finance Third Edition Using Discounted Cash Flow Analysis to Make Investment Decisions Brealey Myers Marcus slides by Matthew Will Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc.,2001
7-2 Topics Covered dIscounted Cash flows. Net Profits INcremental Cash flows s Treatment of Inflation SEparation of Investment Financing Decisions EXample: Blooper Industries Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 7- 2 Irwin/McGraw-Hill Topics Covered Discounted Cash Flows, NetProfits Incremental Cash Flows Treatment of Inflation Separation of Investment & Financing Decisions Example: Blooper Industries
7-3 Cash Flow Vs Accounting Income s Discount actual cash flows O Using accounting income, rather than cash flow could lead to erroneous decisions Example A project costs $2, 000 and is expected to last 2 years,producing cash income of $1, 500 and $500 respectively. The cost of the project can be depreciated at $1,000 per year. Given a 10% required return, compare the NPy using cash flow to the NPv using accounting income Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 7- 3 Irwin/McGraw-Hill Cash Flow vs. Accounting Income Discount actual cash flows Using accounting income, rather than cash flow, could lead to erroneous decisions. Example A project costs $2,000 and is expected to last 2 years, producing cash income of $1,500 and $500 respectively. The cost of the project can be depreciated at $1,000 per year. Given a 10% required return, compare the NPV using cash flow to the NPV using accounting income
7-4 Cash Flow Vs Accounting Income Year 1 Year 2 Cash Income $1500$500 Depreciation -$1000-$1000 Accounting Income 500 500 Accounting NPV 500-500 $41.32 1.10(1.10) Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 7- 4 Irwin/McGraw-Hill Year 1 Year 2 Cash Income $1500 $ 500 Depreciation -$1000 -$1000 Accounting Income + 500 - 500 Accounting NPV = 500 1.10 + − = 500 110 32 2 ( . ) $41. Cash Flow vs. Accounting Income
7-5 Cash Flow Vs Accounting Income Today Year 1 Year 2 Cash Income $1500$500 Project Cost 2000 Free Cash flow -2000 +1500 +500 20001500500 Cash npv $22314 1.10(10)2(1.10) Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 7- 5 Irwin/McGraw-Hill Today Year 1 Year 2 Cash Income $1500 $ 500 Project Cost - 2000 Free Cash Flow - 2000 +1500 + 500 Cash NPV = - 2000 1.10 + + = − 1500 110 500 110 14 2 3 ( . ) ( . ) $223. Cash Flow vs. Accounting Income