Tiếng anh chuyên ngành kế toán part 32 pot

298 Planning and Forecasting later. Since the cash flow is deferred, the true value of that sale to the firm is somewhat diminished. By focusing on cash flows and when they occur, NPV reflects the true value of increased revenues and costs. Consequently, NPV analysis requires that accounting data be unraveled to reveal the underlying cash flows. That is why changes in net working capital must be accounted for and why deprecia- tion does not show up directly. Principle No. 2: Use Expected Values There is always going to be some uncertainty over future cash flows. Future costs and revenues cannot be known for sure. The analyst must gather as much information as possible and assemble it to construct expected values of the input variables. Although expected values are not perfect, these best guesses have to be good enough. What is the alternative? The uncertainty in forecast- ing the inputs is accounted for in the discount rate that is later used to discount the expected cash flows. Principle No. 3: Focus on the Incremental NPV analysis is done in terms of “incremental” cash flows—that is, the change in cash flow generated by the decision to undertake the project. Incremental cash flow is the difference between what the cash flow would be with the proj- ect and what the firm’s cash flow would be without the project. Any sales or savings that would have happened without the project and are unaffected by doing the project are irrelevant and should be ignored. Similarly, any costs that would have been incurred anyway are irrelevant. It is often difficult yet nonetheless important to focus on the incremental when calculating how cash flows are impacted by opportunity costs, sunk costs, and overhead. These trou- blesome areas will be elaborated on next. Opportunity Costs Opportunity costs are opportunities for cash inflows that must be sacrificed in order to undertake the project. No check is written to pay for opportunity costs, but they represent changes in the firm’s cash flows caused by the project and must, therefore, be treated as actual costs of doing the project. For exam- ple, suppose the firm owns a parking lot, and a proposed project requires use of that land. Is the land free since the firm already owns it? No; if the project were not undertaken then the company could sell or rent out the land. Use of the company’s land is, therefore, not free. There is an opportunity cost. Money that could have been earned if the project were rejected will not be earned if the project is started. In order to reflect fully the incremental impact of the proposed project, the incremental cash flows used in NPV analysis must incor- porate opportunity costs. Planning Capital Expenditure 299 Sunk Costs Sunk costs are expenses that have already been paid or have already been com- mitted to. Past research and development are examples. Since sunk costs are not incremental to the proposed project, NPV analysis must ignore them. NPV analysis is always forward-looking. The past cannot be changed and so should not enter into the choice of a future course of action. If research was under- taken last year, the effects of that research might bear on future cash flows, but the cost of that research is already water under the bridge and so is not rel- evant in the decision to continue the project. The project decision must be made on the basis of whether the project increases or decreases wealth from the present into the future. The past is irrelevant. Overhead The treatment of overhead often gives project managers a headache. Overhead comprises expenditures made by the firm for resources that are shared by many projects or departments. Heat and maintenance for common facilities are examples. Management resources and shared support staff are other examples. Overhead represents resources required for the firm to provide an environ- ment in which projects can be undertaken. Different firms use different for- mulas for charging overhead expenses to various projects and departments. If overhead charges accurately reflect the shared resources used by a project, then they should be treated as incremental costs of operating the project. If the project were not undertaken, those shared resources would benefit another moneymaking project, or perhaps the firm could possibly cut some of the shared overhead expenditures. Thus, to the extent that overhead does repre- sent resources used by the project, it should be included in calculating incre- mental cash flows. If, on the other hand, overhead expense is unaffected by the decision to undertake the new project, and no other proposed project could use those shared resources, then overhead should be ignored in the NPV analysis. Sometimes the formulas used to calculate overhead for budgeting purposes are unrealistic and overcharge projects for their use of shared resources. If the fi- nancial analyst does not correct this unrepresentative allocation of costs, some worthwhile projects might incorrectly appear undesirable. COMPUTING NPV: THE TIME VALUE OF MONEY In deciding whether a project is worthwhile, one needs to know more than whether it will make money. One must also know when it will make money. Time is money! Project decisions involve cash flows spread out over several pe- riods. As we shall see, cash flows in different periods are distinct products in the financial marketplace—as different as apples and oranges. To make deci- sions affecting many future periods, we must know how to convert the differ- ent periods’ cash flows into a common currency. 300 Planning and Forecasting The concept that future cash flows have a lower present value and the set of tools used to discount future cash flows to their present values are collec- tively known as “time value of money” (TVOM) analysis. I have always thought this to be a misnomer; the name should be the “money value of time.” But there is no use bucking the trend, so we will adopt the standard nomenclature. You probably already have an intuitive grasp of the fundamentals of TVOM analysis, as your likely answer to the following question illustrates: Would you rather have $100 today or $100 next year? Why? The answer to this question is the essence of TVOM. You no doubt an- swered that you would rather have the money today. Money today is worth more than money to be delivered in the future. Even if there were perfect cer- tainty that the future money would be received, we prefer to have money in hand today. There are many reasons for this. Having money in hand allows greater flexibility for planning. You might choose to spend it before the future money would be delivered. If you choose not to spend the money during the course of the year, you can earn interest on it by investing it. Understanding TVOM allows you to quantify exactly how much more early cash flows are worth than deferred cash flows. An example will illuminate the concept. Suppose you and a friend have dinner together in a restaurant. You order an inexpensive sandwich. Your friend orders a large steak, a bottle of wine, and several desserts. The bill arrives and your friend’s share is $100. Unfortu- nately, your friend forgot his wallet and asks to borrow the $100 from you. You agree and pay. A year passes before your friend remembers to pay you back the money. “Here is the $100,” he finally says one day. Such events test a friend- ship, especially if you had to carry a $100 balance on your credit card over the course of the year on which interest accrued at a rate of 18%. Is the $100 that your friend is offering you now worth the same as the $100 that he borrowed a year earlier? Actually, no; a $100 cash flow today is not worth $100 next year. The same nominal amount has different values depending on when it is paid. If the interest rate is 18%, a $100 cash flow today is worth $118 next year and is worth $139.24 the year after because of compound interest. The present value of $118 to be received next year is exactly $100 today. Your friend should pay you $118 if he borrowed $100 from you a year earlier. The formula for converting a future value to a present value is: where PV stands for present value, FV is future value, n is the number of peri- ods in the future that the future cash flow is paid, and r is the appropriate in- terest rate or discount rate. Discounting Cash Flows Suppose in the brewery example that the appropriate discount rate for translat- ing future values to present values was 20%. Recall that the brewery project PV FV r n = + () 1 Planning Capital Expenditure 301 was forecast to generate $2.42 million of cash in year 1. The present value of that cash flow, as of year 0, is $2,016,670, computed as follows: Similarly, the year-2 cash flow was forecast to be $2.42 million also. The pres- ent value of that second-year cash flow is only $1,680,560: The longer the time over which a cash flow is discounted, the lower is its pres- ent value. Exhibit 10.4 presents the forecasted cash flows and their discounted present values for the brewery project. Summing the Discounted Cash Flows to Arrive at NPV Finally, we can calculate the NPV. The NPV is the sum of all discounted cash flows, which in the brewery example equals $614,000. To understand precisely what this means, observe that the sum of the discounted cash flows from years 1 through 10 is $10,614,000. This means that the project generates future cash flows that are worth $10,614,000 today. The initial cost of the project is $10,000,000 today. Thus, the project is worth $10,614,000 but costs only $10,000,000 and therefore creates $614,000 of new wealth. The managers of the beer company would be well advised to adopt this project, because it has a positive NPV and therefore creates wealth. PV = () = $, , . $, , 2 420 000 120 1 680 560 2 PV = () = $, , . $, , 2 420 000 120 2 016 670 1 EXHIBIT 10.4 Discounted cash f lows for brewery project (thousands). Year Cash Flow Discounted Cash Flow 0 $(10,000) $(10,000) 1 2,420 2,017 2 2,420 1,681 3 2,420 1,400 4 2,420 1,167 5 2,420 973 6 2,420 810 7 2,420 675 8 2,420 563 9 2,420 469 10 5,320 859 302 Planning and Forecasting MORE NPV EXAMPLES Consider two alternative projects, A and B. They both cost $1,000,000 to set up. Project A returns $800,000 per year for two years starting one year after setup. Project B also returns $800,000 per year for two years, but the cash flows begin two years after setup. The firm uses a discount rate of 20%. Which is the better project, A or B? Like project A, project C also costs $1,000,000 to set up, and it will pay back $1,600,000. For both A and C, the firm will earn $800,000 per year for two years starting one year after setup. However, C costs $500,000 initially and the other $500,000 need only be paid at the termination of the project (it may be a cleanup cost, for example). Project A requires the initial outlay all at once at the outset. Which is the better project, A or C? Of projects A, B, and C, which project(s) should be undertaken? We should make the project decision only after analyzing each project’s NPV. Exhibit 10.5 tabulates each project’s cash flows, discounted cash flows, and NPVs. The NPVs of Projects A, B, and C, are, respectively, $222,222, −$151,235, and $375,000. Project C has the highest NPV. Therefore, if only one project can be selected, it should be project C. If more than one project can be undertaken, then both A and C should be selected since they both have positive NPVs. Project B should be rejected since it has a negative NPV and would therefore destroy wealth. It makes sense that project C should have the highest NPV, since its cash outflows are deferred relative to the other projects, and its cash inflows are early. Project B, alternatively has all costs up front, but its cash inflows are deferred. Suppose a project has positive NPV, but the NPV is small, say, only a few hundred dollars. The firm should nevertheless undertake that project if there are no alternative projects with higher NPV. The reason is that a firm’s value is increased every time it undertakes a positive-NPV project. The firm’s value increases by the amount of the project NPV. A small NPV, as long as it is posi- tive, is net of all input costs and financing costs. So, even if the NPV is low, EXHIBIT 10.5 Cash f lows and discounted cash f lows for three alternative projects (thousands). Project A Project B Project C Project A Discounted Project B Discounted Project C Discounted Year Cash Flow Cash Flow Cash Flow Cash Flow Cash Flow Cash Flow 0 $(1,000,000) $(1,000,000) $(1,000,000) $(1,000,000) $(500,000) $(500,000) 1 800,000 666,667 0 0 800,000 666,667 2 800,000 555,556 0 0 300,000 208,333 3 0 0 800,000 462,963 0 0 4 0 0 800,000 385,802 0 0 NPV = $0,(222,222 $0,(151,235) $ 375,000 Planning Capital Expenditure 303 the project covers all its costs and provides additional returns. If accepting the small-NPV project does not preclude the undertaking of a higher-NPV project, then it is the best thing to do. A firm that rejects a positive-NPV proj- ect is rejecting wealth. Of course, this does not mean a firm should jump headlong into any proj- ect that at the moment appears likely to provide positive NPV. Future poten- tial projects should be considered as well, and they should be evaluated as potential alternatives. The projects, current or future, that have the highest NPV should be the projects accepted. For maximum wealth-creation effi- ciency, the firm’s managerial resources should be committed toward under- taking maximum NPV projects. THE DISCOUNT RATE At what rate should cash flows be discounted to compute net present values? In most cases, the appropriate rate is the firm’s cost of funds for the project. That is, if the firm secures financing for the project by borrowing from a bank, the after-tax interest rate should be used to discount cash flows. If the firm obtains funds by selling stock, then an equity financing rate should be applied. If the financing combines debt and equity, then the appropriate discount rate would be an average of the debt rate and the equity rate. Cost of Debt Financing The after-tax interest rate is the interest rate paid on a firm’s debt less the im- pact of the tax break they get from issuing debt. For example, suppose that a firm pays 10% interest on its debt and the firm’s income tax rate is 40%. If the firm issues $100,000 of debt, then the annual interest expense will be $10,000 (10% × $100,000). But this $10,000 of interest expense is tax deductible, so the firm would save $4,000 in taxes (40% × the $10,000 interest). Thus, net of the tax break, this firm would be paying $6,000 to service a $100,000 debt. Its after-tax interest rate is 6% ($6,000/$100,000 principal). The formula for after-tax interest rate (R D, after-tax ) is: where R D is the firm’s pretax interest rate, and τ is the firm’s income tax rate. Borrowing from a bank or selling bonds to raise funds is known as “debt financing.” Issuing stock to raise funds is known as “equity financing.” Equity financing is an alternative to debt financing, but it is not free. When a firm sells equity, it sells ownership in the firm. The return earned by the new sharehold- ers is a cost to the old shareholders. The rate of return earned by equity in- vestors is found by adding dividends to the change in the stock price and then dividing by the initial stock price: RR DD, () after-tax =−1 τ 304 Planning and Forecasting where R E is the return on the stock and also the cost of equity financing, D is the dollar amount of annual dividends per share paid by the firm to stockhold- ers, P 0 is the stock price at the beginning of the year, and P 1 is the stock price at the end of the year. For example, suppose the stock price is $100 per share at the beginning of the year and $112 at the end of the year, and the dividend is $8 per share. The stockholders would have earned a return of 20%, and this 20% is also the cost of equity financing: The capital asset pricing model (CAPM) is often used to estimate a firm’s cost of equity financing. The idea behind the CAPM is that the rate of return demanded by equity investors will be a function of the risk of the equity, where risk is measured by a variable beta (β). According to the CAPM, β and cost of equity financing are related by the following equation: where R F is a risk-free interest rate, such as a Treasury bill rate, and R M is the expected return for the stock market as a whole. For example, suppose the ex- pected annual return to the overall stock market is 12%, and the Treasury bill rate is 4%. If a stock has a β of 2, then its cost of equity financing would be 20%, computed as follows: Analysts often use the Standard & Poor’s 500 stock portfolio as a proxy for the entire stock market when estimating the expected market return. The βs for publicly traded firms are available from a variety of sources, such as Bloomberg, Standard & Poor’s, or the many companies that provide equity re- search reports. How β is computed and the theory behind the CAPM are be- yond the scope of this chapter, but the textbooks listed in the bibliography to this chapter provide excellent coverage. Weighted Average Cost of Capital Most firms use a combination of both equity and debt financing to raise money for new projects. When financing comes from two sources, the appropriate dis- count rate is an average of the two financing rates. If most of the financing is debt, then debt should have greater weight in the average. Similarly, the weight given to equity should reflect how much of the financing is from equity. The R E =+× − () [] =4 2 12 4 20%%%% RR RR EF MF =+ − () β R E = +− = $$ $ $ % 8 112 100 100 20 R DP P P E = +− 10 0 Planning Capital Expenditure 305 resulting number, the “weighted average cost of capital” (WACC), reflects the firm’s true cost of raising funds for the project: where W E is the proportion of the financing that is equity, W D is the propor- tion of the financing that is debt, R E is the cost of equity financing, R D is the pretax cost of debt financing, and τ is the tax rate. For example, suppose a firm acquires 70% of the funds needed for a proj- ect by selling stock. The remaining 30% of financing comes from borrowing. The cost of equity financing is 20%, the pretax cost of debt financing is 10%, and the tax rate is 40%. The weighted average cost of capital would then be 15.8%, computed as follows: This 15.8% rate should then be used for discounting the project cash flows. Most often the choice of the discount rate is beyond the authority of the project manager. Top management will determine some threshold discount rate and dictate that it is the rate that must be used to assess all projects. When this is the policy, the rate is usually the firm’s WACC with an additional margin added to compensate for the natural optimism of project proponents. A higher WACC makes NPV lower, and this biases management toward rejecting projects. The Effects of Leverage Leverage refers to the amount of debt financing used: the greater the ratio of debt to equity in the financing mix, the greater the leverage. The following ex- ample illustrates how leverage impacts the returns generated by a project. Sup- pose we have two companies that both manufacture scooters. One company is called NoDebt Inc., and the other is called SomeDebt Inc. As you might guess from its name, NoDebt never carries debt. SomeDebt is financed with equal parts of debt and equity. Neither company knows whether the economy will be good or bad next year, but they can make projections contingent on the state of the economy. Exhibit 10.6 presents balance-sheet and income-statement data for the two companies for each possible business environment. Each company has $1 million of assets. Therefore, the value of NoDebt’s equity is $1 million, since debt plus equity must equal assets—the balance- sheet equality. Since SomeDebt is financed with an equal mix of debt and eq- uity, its debt must be worth $500,000, and its equity must also be worth $500,000. Aside from capital structure—that is, the mix of debt and equity used to finance the companies—the two firms are identical. In good times both com- panies make $1 million in sales. In bad times sales fall to $200,000. Cost of goods sold is always 50% of sales. Selling, administrative, and general expenses are a constant $50,000. For simplicity we assume there is no depreci ation. WACC =× () +× ×− () [] =07 20 03 10 1 40 158.%. % % .% WACC W R W R EE D D =+ − () [] 1 τ 306 Planning and Forecasting Earnings before interest and taxes (EBIT) is thus $450,000 for both companies in good times, and $50,000 for both in bad times. So far, this example illus- trates an important lesson about leverage: Leverage has no impact on EBIT. If we define return on assets (ROA) 1 as EBIT divided by assets, then leverage has no impact on ROA. If the pre-tax interest rate is 10%, however, then SomeDebt must pay $50,000 of interest on its outstanding $500,000 of debt, regardless of whether business is good or bad. NoDebt, of course, pays no interest. Because this is a standard income statement, not a capital budgeting cash-flow computation, we must account for interest. EBT (earnings before taxes, which is the same thing as taxable income) for NoDebt is the same as its EBIT: $450,000 in good times and $50,000 in bad times. For SomeDebt, however, EBT will be $50,000 less in both states: $400,000 in good times and zero in bad times. Income tax is 40% of EBT, so it must be $180,000 for NoDebt in good times, $20,000 for NoDebt in bad times, $160,000 for SomeDebt in good times, and zero for SomeDebt in bad times. Here we see the second important lesson about leverage: Leverage reduces taxes. Net earnings is EBT minus taxes. For NoDebt, net earnings is $270,000 in good times and $30,000 in bad times. For SomeDebt, net earnings is $240,000 in good times and zero in bad times. Return on equity (ROE) equals net earn- ings divided by equity. ROE is the profit earned by the equity investors as a function of their equity investment. If, as in this example, there is no deprecia- tion, no changes in net working capital, and no capital expenditures, then net earnings would equal the cash flow received by equity investors, and ROE would be that year’s cash return on their equity investment. Notice that ROE for NoDebt is 27% in good times and 3% in bad times. ROE for SomeDebt is much more volatile: 48% in good times and 0% in bad times. This is the third EXHIBIT 10.6 Performance of NoDebt Inc. and SomeDebt Inc. NoDebt Inc. (thousands) SomeDebt Inc. (thousands) Net Earnings Good Times Bad Times Good Times Bad Times Assets $1,000 $1,000 $1,000 $1,000 Debt 0 0 500 500 Equity $1,000 $1,000 $1,500 $1,500 Revenue $1,000 $ 1,200 $1,000 $1,200 COGS 500 100 500 100 SAG 50 50 50 50 EBIT 450 50 450 50 Interest 0 0 50 50 EBT 450 50 400 0 Tax (40%) 180 20 160 0 Net Earnings $ 1,270 $1,030 $1,240 $11,00 ROA 45.0% 5.0% 45.0% 5.0% ROE 27.0% 3.0% 48.0% 0.0% Planning Capital Expenditure 307 and most important lesson to be learned about leverage from this example: For the equity investors, leverage makes the good times better and the bad times worse. One student of mine, upon hearing this, exclaimed, “Leverage is a lot like beer!” Because leverage increases the riskiness of the cash flows to equity in- vestors, leverage increases the cost of equity capital. But for moderate amounts of leverage, the impact of the tax shield on the cost of debt financing over- whelms the rising cost of equity financing, and leverage reduces the WACC. Economists Franco Modigliani and Merton Miller were each awarded the Nobel Prize in economics (in 1985 and 1990, respectively) for work that in- cluded research on this very issue. Modigliani and Miller proved that in a world where there are no taxes and no bankruptcy costs the WACC is unaffected by leverage. What about the real world in which taxes and bankruptcy exist? What we learn from their result, known as the Modigliani-Miller irrelevance theo- rem, is that as leverage is increased WACC falls because of the tax savings, but eventually WACC starts to rise again due to the rising probability of bank- ruptcy costs. The choice of debt versus equity financing must balance these countervailing concerns, and the optimal mix of debt and equity depends on the specific details of the proposed project. Divisional versus Firm Cost of Capital Suppose the beer company is thinking about opening a restaurant. The risk in- herent in the restaurant business is much greater than the risk of the beer brewing business. Suppose the WACC for the brewery has historically been 20%, but the WACC for stand-alone restaurants is 30%. What discount rate should be used for the proposed restaurant project? Considerable research, both theoretical and empirical, has been applied to this question, and the consensus is that the 30% restaurant WACC should be used. A discount rate must be appropriate for the risk and characteristics of the project, not the risk and characteristics of the parent company. The reason for this surprising result is that the volatility of the project’s cash flows and their correlation with other risky cash flows are the paramount risk factors in determining cost of capital, not simply the likelihood of default on the com- pany’s obligations. The financial analyst should estimate the project’s cost of capital as if it were a new restaurant company, not an extension of the beer company. The analyst should examine other restaurant companies to determine the appropriate β, cost of equity capital, cost of debt financing, financing mix, and WACC. OTHER DECISION RULES Some firms do not use the NPV decision rule as the criterion for deciding whether a project should be accepted or rejected. At least three alternative de- cision rules are commonly used. As we shall see, however, the alternative rules . moment appears likely to provide positive NPV. Future poten- tial projects should be considered as well, and they should be evaluated as potential alternatives. The projects, current or future,. Different firms use different for- mulas for charging overhead expenses to various projects and departments. If overhead charges accurately reflect the shared resources used by a project, then they. 1,681 3 2,420 1,400 4 2,420 1,167 5 2,420 973 6 2,420 810 7 2,420 675 8 2,420 563 9 2,420 469 10 5 ,320 859 302 Planning and Forecasting MORE NPV EXAMPLES Consider two alternative projects, A and