Example: Definition of OCF
With no Taxes: $
Project Cost = Intial Investment(II) 100
Project life time,in years (N) 1
Equity 50
Debt 50
Cost of Equity (ROE) 25%
Cost of Debt (interest Rate) 10%
Calculate WACC
WAAC = 0.25(0.50) + 0.10(0.50)
= 0.125 + 0.05
= 0.175
Calculate OCF
EBIT $ 17.5
Add:Depreciation allowance $ 100
OCF $ 117.5
Calculate NPV
DOCF(at WACC)= $ 100
NPV = 100-100= 0
Distribution of value and return at end of one year
Distribution with no Taxes
Distribution from depreciation= $ 100
Debt holders $ 50
Shareholders $ 50
Distribution from EBIT= $ 17.50
Debt holders $ 5
Shareholders $ 12.5
With Taxes: $
Tax Rate (t) 40%
Project Cost = Intial Investment(II) 100
Project life time,in years (N) 1
Equity 50
Debt 50
cost of debt before tax (Interest Rate) 10%
Cost of debt after tax = 0.1(1-0.40) 6%
Cost of Equity (ROE) 15%
Calculate WACC
WACC= 0.50(0.15)+0.5(0.06)
= 0.075+0.030
= 0.105
Calculate OCF
EBIT $ 17.5
(EBIT) after tax= (EBIT)(1-t)
(EBIT) after tax= $ 17.5(0.6)
(EBIT) after tax= $ 10.5
EBIT (after tax)=(EBT)(1-t) + int(1-t)= 12.5(1-0.4) + 5 (1-0.4)
(EBIT) after tax= 7.5 + 3
(EBIT) after tax= $ 10.5
Add:Depreciation allowance $ 100
OCF $ 110.5
Calculate NPV
DOCF(at WACC)= $ 100
NPV =100-100= 0
Distribution with Taxes
Distribution from depreciation= $ 100
Debt holders $ 50
Shareholders $ 50
Distribution from EBIT before Tax =$ 17.50
Debt holders $ 5
Shareholders = $ 7.5
Taxes= $ 5
Opening Balance Sheet
Assets Liab & Equity
Gross F/A $ 100 Debt $ 50
Equity $ 50
Total Assets $ 100 Total Liab & Equity $ 100
Ending Balance Sheet
Assets Liab & Equity
cash $ 100 Debt $ 50
Gross F/A $ 100 Equity $ 50
Less: Acc Dep $ 100
Total Assets $ 100 Total Liab & Equity $ 100