Project Cash Flow Estimation

1
Project Cash Flow Estimation

• Financial Management

2
Project Cash Estimation

• Significance of Cash Flows and Cash Flow
  Estimation
• The concept of relevant versus irrelevant
  cash flows
• Points to watch in estimating cash flows
• How to estimate project operating cash flows?
• How to estimate project total cash flows?

3
Cash Flows

• To be consistent with wealth maximization
  principle, an evaluation of a project must be
  based on cash flows and not on accounting profits
• To be able to use NPV technique or any other
  technique of capital budgeting analysis
  successfully and accurately, we must have
• an unbiased estimate of the expected future cash
  flows of the project
• including time to completion and estimate initial
  investment/cost
• extremely important and most difficult task

4

• Projects have failed or succeeded due to
  incorrect or correct estimates of the cash flows
  of the project.
• If cash flow estimates are incorrect, it doesnt
  matter which technique we use, the project is
  doomed to fail

5
Relevant versus Irrelevant Cash Flows

• The results of an acceptance of a project is to
  change the cash flows of a firm.
• Cash flows of a firm that change because of the
  project are called relevant cash flows
• Any cash flows that does not change irrespective
  of the acceptance/rejection of the project is
  irrelevant to decision making and should not be
  considered.

6
Points of Consider

• Sunk Costs
• Opportunity Costs
• Project Externalities
• Change in Net Working Capital

7
Sunk Costs

• Sunk CostsA cost that has already been incurred
  and cannot be recovered irrespective of the
  decision to accept or reject the project.
• RD, Market Research, Consultants Fees
• Is it relevant or irrelevant?

8
Opportunity Costs

• Opportunity Costs--The cash flow foregone by
  using your resources in a particular way.
• Resources have multiple uses
• You can use them in one way to the exclusion of
  other uses and this gives rise to opportunity
  costs
• By using your own building for your business, you
  forego the rent that you could have earned by
  renting it to some one else.
• Is it relevant or irrelevant to decision making?

9
Project Externalities

• Project Externalities--the effect of a new
  project (positive or negative) on an existing
  project or division of a firm.
• For instance, introduction of a new model of a
  car on other existing models produced by the same
  firm.
• Is it relevant or irrelevant to decision making?

10
Net Working Capital

• Change in Net Working Capital--Net working
  capital is defined as current assets minus
  current liabilities.
• Investment in working capital is a cash outflow
  during the year in which investment takes place
• Any investment in working capital is a cash
  inflow during the last year of the project and
  must be treated accordingly

11
Estimating Project Cash Flows

• Total Cash Flows of a Project in year t, where t
  ranges from year 0 to year n.
• Project Operating Cash Flows for that
  particular year change in Net Working Capital
  initial investment
• There is no project operating cash flows for year
  0

12
Estimating Project Operating Cash Flows

• Cash flows from operations for any year
• Estimated Sales Revenue
• Total Costs
• Variable Costs
• Fixed Costs
• per year
• Depreciation
• Sales Revenue minus Total Costs Earnings Before
  Interest and Taxes (EBIT)
• Deduct Taxes from EBIT
• Net Income

13

• Operating Cash Flows Net Income Depreciation
  OR
• Operating Cash Flows EBIT Taxes Depreciation