Beruflich Dokumente
Kultur Dokumente
1
4.2.1 Project Cash Flows
The effect of taking a project is to change the firm’s
overall cash flows today and in the future.
To evaluate a proposed investment, we must
consider these changes in the firm’s cash flows and
then decide whether or not, they add value to the
firm.
The first and most important step, therefore is to
decide:
4
1. Stand Alone Principle
There are two sides of a project, viz, the investment (or assets)
side and the financing side.
Cash flows associated with these sides should be separated.
6
Separation Principle (contd…)
Project
Tax-Adjusted Interest
10
Guidelines to estimate incremental cash flow
12
Guidelines (contd….)
Example:
If a project uses resources already available with the firm,
there’s a potential for an opportunity cost.
Is there any alternative use of the resource is the project is
not undertaken ?
14
Guidelines (contd….)
If a project uses a vacant factory building owned
by the firm, the revenue that can be derived from
renting out this building represents the
opportunity cost.
If a project uses an equipment which is currently
idle, its opportunity cost is its sales price, net of
any tax liability.
If a project requires the services of some
experienced engineers from an existing division of
the firm, the cost that is borne by that division to
replace those engineers represents the opportunity
cost. 15
Guidelines (contd….)
What happens when a project uses a resource that has no
current alternative use, but some potential alternative use ?
Example: Excess Capacity on Some Machine AND Using
that excess capacity for a new product
Case I: May exhaust capacity much earlier than otherwise and
hence may call for creating new capacity earlier rather than
later
Opportunity cost = PV of creating capacity earlier – PV or
creating capacity later.
Case II: May reduce the output of some products in future.
Opportunity Cost = Loss in cash flows that would have
otherwise been generated by the sales of those products.
16
Guidelines (contd….)
d) Question the allocation of Overhead Costs
Issues:
19
Relevant Tax Rate
20
Treatment of Losses
22
5. Consistency Principle
Investors’ Group:
The cash flow of a project may be estimated from the point
of view of all investors (equity shareholders as well as
lenders) or from the point of view of just equity
shareholders.
23
Consistency Principle (contd…)
24
Consistency Principle (contd…)
26
Consistency Principle (contd…)
Inflation:
Nominal Cash flowt = Real Cash flow (1+ Expected inflation rate)t
Nominal Discount rate =
(1+ Real discount rate)(1+Expected inflation rate) - 1
27
Elements of the Cash Flow Stream
Year
0 1 2 3
31
Illustration (contd…)
EBIT 33,000
Depreciation + 30,000
Taxes @ 34 % - 11,220
Year
0 1 2 3
37
Cash Enterprises (contd…)
38
Illustration 2 – Pharma Limited
39
Pharma Limited (contd…)
40
Pharma Limited (contd…)
41
Pharma Limited (contd…)
42
Pharma Limited (contd…)
43
Illustration 3 (Ojus Enterprises)
44
Ojus Enterprises (contd…)
45
Ojus Enterprises (contd…)
46