Fin 701 Partial Recap 4

Partial Recap of Class #4

• We will spend substantial time working on the Agnew Convenience Store case.

O How can we convert operating earnings (frequently called PNI for Project Net Income or NOPAT for Net Operating Profit After Tax) to OCFAT (for Operating Cash Flow After Tax)? Which is more important from an economic point of view?

OCFAT adds back in the depreciation expense to NOPAT since depreciation is not a cash flow. OCFAT is more important OCFAT investors are more interested in cash not accounting methods.

(Revenues - Operating Cost) * (1-T) + (Depreciation * T)

O What’s the difference between accounting Net Income and NOPAT?

Net income

- Interest income after taxes

Total profit after tax

+ Interest expense after taxes

NOPAT

O What economic logic underpins the decision to ignore financing costs (interest and dividends) when computing a project’s contribution to operating earnings?

Because we separate the decision management chooses whether to finance using debt or equity. We are focused on the cash flows produced by the assets.  Assets are harder to get or sell.  Financing is easy.

O What does the term “depreciation tax shield” mean?

The tax savings that results from depreciation expense or the reduction in taxable income based on the deduction taken away from depreciation.

O Can you track the use of the worksheet and the narrative of the case to find the initial outflow, the ending cash flow, and total cash flow?

Yes

O What impacts do switching between LIFO and FIFO have on earnings, cash flow, and value?

Switching between LIFO and FIFO have on earnings and cash flow values; Our earnings INCREASE so our cash flow decreases because we pay more in taxes so the firm value decreases

Switching between FIFO and LIFO have on earnings and cash flow values; Our earnings Decrease so our cash flow increases because we pay less in taxes so the firm value INCREASES

O Can you evaluate the Agnew project by computing, and trying to...