PFS: Financial Aspect-Project

Financing and Evaluation

Chapter 26
(PART I)
 Determining Funds
Requirement and
Profitability
O Projected Statement of Comprehensive
Income
O Projected Statement of Financial Position
O Projected Cash Flow Statement
 Sources of Financing
O Equity
O Loan financing
O Short-term loans
O Long term loans
Economic
Evaluation
Break-even Analysis

O determines the break-even point at which

sales revenue equal production costs and
expenses
O level of capacity utilization at which sales
revenues and production costs and
expenses match each other
Assumptions to consider:

1. Factoring of Accounts receivable

2. Banker's acceptances
Assumptions observed prior to
BEP calculation
1. Production costs are a function of volume of
production or of sales
2. Volume of production = Volume of sales
3. Fixed operating costs are the same for every
volume f production
4. Variable unit costs vary in proportion to the
volume of production
5. Unit sales price for a product or product mix are
the same for all levels of output over time
6. Data from a normal year of operation
should be taken
7. Level of unit sales prices, variable, and fixed
operating costs remain constant.
8. Single product is manufactured, or if several
similar ones are produced, mix should be
convertible into single product
9. Product mix should remain the same over
time
Break-even Formula:

a. BEP (units) = Fixed Costs / CM per unit

(SP/unit-VC/unit)
b. BEP (Pesos)= Fixed Costs / CM ratio
(CM/SP)
Net Present Value

O Screens and ranks investment proposals

O Difference between the Present value of
Cash inflows and Cash outflows with the
investment projects
Procedure:

1. Find PV of each projects cash flow

2. Sum discounted cash flows; Project's NPV
Decision Rule:

1. positive NPV - Accept

2. negative NPV - Reject
3. two projects mutually exclusive - higher NPV,
provided its NPV is positive
Internal Rate of Return

O Discount rate that will cause the NPV of an

investment project to be equal to zero.
internal yield promised by a project over its
useful life
Procedure

1. If same net cash inflow every year,

INVESTMENT / EXPECTED NET ANNUAL CASH
FLOW
2. Factor derived in (1.) is located in the PV
tables
3. Interpolate if necessary, to get exact rate of
return
Decision Rule

1. IRR> or equals cost of capital - Accept

2. IRR< cost of capital - Reject
3. two projects mutually exclusive- higher IRR,
provided it exceeds or equals to cost of capital
Discounted Payback Period

O length of time required for the net revenues

of an investment discounted at the
investment’s cost of capital to cover the cost
of investment.
Procedure

1. Compute the Present Value of Cash Inflows

2. Cumulate the PV of cash inflows until it

equals the initial outflow. Determine the
number of years to accomplish such

O Decision Rule: the shorter period the better.

Payback Period

O -length of time it takes for an investment to recoup its own

initial cost out of the cash receipts that it generates.

Procedure
1. When the net annual cash inflow the same every year:
Investment required / Net annual cash flow

2. When the net annual cash inflow is not uniform every year:
Add the annual cash inflow until it equals the investment required
Decision Rule
1. Payback period < or equal to maximum
allowable payback period, ACCEPT

2. Payback period > Maximum allowable

payback period, REJECT
Accounting Rate of Return

O rate of return promised by an investment project

when the time value of money is not considered.

Procedure
ARR= Incremental Revenues less incremental costs and
expenses / Initial Investment
OR
ARR= Annual Cash Inflow from operation - Incremental
annual depreciation / Initial Investment
Decision Rule

1. ARR > or = Desired Rate of Return, ACCEPT

2. ARR<Desired rate of return, REJECT
Financial Analysis

O application of Financial ratios to assess the

project situation regarding the
1. Liquidity
2. Profitability
3. Solvency
Sensitivity Analysis

O Financial studies involve projected data,

developed under specific assumptions.
Uncertainty is therefore an unavoidable
element.
O Sensitivity analysis can be used to "minimize
the effect of uncertainty"
O Used to determine the impact of a change in
a factor (s) influencing a projected result.