Capital budgeting
Building a project model
Turn a project's operating plan into after-tax free cash flows, with depreciation, working capital and resale value.
Learning objectives
- Calculate operating cash flow with the depreciation tax shield
- Model working capital investment and recovery over a project's life
- Include the after-tax resale value of project assets
- Build a linked Inputs / Calculations / Outputs project model and read its NPV and IRR
Real projects pay tax, depreciate their assets, tie up cash in stock and receivables, and sell their equipment at the end. A project model brings these together year by year so that the decision metric, NPV, rests on after-tax free cash flow: the cash the project returns to all the company's investors.
Depreciation is not a cash flow, but it matters: it reduces taxable profit and therefore the tax the company pays. That saving, the depreciation tax shield, is real cash.
FCF = EBIT × (1 − t) + Depreciation − Capex − ΔWorking capital
- EBIT
- revenue − cash costs − depreciation
- t
- tax rate (illustrative in this track)
- Depreciation
- added back because it is not a cash payment; it only lowers tax
- ΔWorking capital
- increase in the working capital balance (an outflow); a decrease is an inflow
Included with a Formula Quest membership
The rest of this lesson is for members. Members get the full lesson, including its 2 graded exercises, and every other Finance Quest lesson.