Introduction to Finance

Operating 
Cash Flows
Salvage 
Value
Total 
Incremental 
Cash Flows
0
–$170,000
$0
$0
–$170,000
1
0
X
0
X
2
0
X
0
X
3
0
X + $40,000
$12,000
X + $52,000

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Problems
563
$70,000, its annual depreciation expense is $40,000, and the fi rm’s tax rate is 40 percent. We 
can ignore the change in net working capital as we incorporated that in the analysis in Table 
LE17.7 and the cash fl ow estimate of $66,417.58. Using equation 17-4 and simplifying, we 
have the following:
Operating cash fl ow = (Sales – Costs – Depreciation) (1 – 
T
) 
+ Depreciation – change in net working capital
$66,417.58 = (Sales – $70,000 – $40,000) (1 – 0.40) + $40,000 – 0
$66,417.58 = (Sales – $110,000) (0.60) + $40,000 
$66,417.58 = (Sales) (0.60) – $66,000 + $40,000 
$66,417.58 = (Sales) (0.60) – $26,000
$92,417.58 = (Sales) (0.60)
Solving for sales to fi nd the minimum total sales revenue, we see sales equals $92,417.58/0.60 = 
$154,029.30 per year. Dividing total annual sales by 100 cycles gives us the minimum bid per 
cycle, $1,540.29. This unit price represents the lowest price the fi rm can bid without adversely 
aff ecting shareholder wealth.
We see from these applications that to approach a cash fl ow estimation problem, we 
should fi rst estimate initial cash outlay, including property and equipment expenditures, 
necessary changes in net working capital, and other start-up expenses, such as hiring new 
workers. Second, we estimate the periodic operating cash fl ows using equation 17-4, making 
sure to include any changes in net working capital over the lifetime of the project. Third, we 
estimate after-tax salvage value cash fl ows. Once we have these three estimates we can use the 
Chapter 17 techniques to estimate NPV, IRR, MIRR, PI, or payback period.
Summary
LO 17.12 
Estimating cash fl ows is a diffi
cult part of evaluating capital 
budgeting projects. Projected earnings, expenses, and fi xed-asset invest-
ments must be converted into cash fl ows by using the methods discussed 
in this chapter. We reviewed practical ways—including the use of mar-
ket research, past experience, and engineering estimates to estimate the 
three main cash fl ows in capital budgeting analysis: initial investment 
outlay, incremental after-tax operating cash fl ows, and salvage value
LO 17.13 
We reviewed the process of estimating the initial invest-
ment outlay, incremental after-tax operating cash fl ows, and salvage 
value and applied to NPV criterion to three types of capital budgeting 
projects: revenue expending; cost saving; and determining a bid price 
that covers all costs, including the cost of capital.
Review Questions
Problems