Project Cash Flows

1
Project Cash Flows

• Engineering Economics Mgmt
• CIVI 322
• Chapter 12

2
Outline

• Types of Projects
• Incremental Cash Flows
• Cash Flow Elements
• Developing Cash Flow Statements
• Generalized Cash Flow Approach

3
Project Types
4
Elements of Cash Flow(Incremental)

• Investment in Assets
• Salvage value
• Working Capital Investment
• Working Capital Release
• Cash Revenues/Savings

• Manufacturing, Operating Maintenance Costs
• Leasing Expenses
• Interest and Repayment of Debt
• Income Taxes and Tax Credits

5
Cash Flows
6
Cash Flow Elements
Recovery of Working Capital
Salvage Value
Operating Cash Inflows
Borrowed Funds
0
1
2
3
N
Operating Cash Outflows
Loan Repayment
Investment in Assets and Working Capital
Net cash flow Cash inflow - cash outflow
7
Classification of Cash Flows

• Operating Activities
• Cash effects of transactions on Net Income
• Investing Activities
• Capital investment
• Salvage value
• Working capital investment or recovery
• Financing Activities
• Debt and repayment of principal

8
Operating Activities

• Sales revenue (inflow)
• Cost savings (inflow)
• Manufacturing expenses (outflow)
• O M cost (outflow)
• Interest payments (outflow)
• Lease expenses (outflow)
• Income taxes (outflow)

9
Investing Activities

• Capital investment (outflow)
• Salvage value (inflow)
• Working capital (outflow)
• Working capital recovery (inflow)
• Gains taxes (outflow)

10
Financing Activities

• Borrowed Amount (inflow)
• Principal repayments (outflow)

11
Developing Cash Flow Statement

• Use net operating income as the starting point to
  get net operating cash flow
• Add back any non-cash expense (mainly
  depreciation)

Net Cash Flow Cash Inflow - Cash Outflow Net
Operating Cash Flow Income after Taxes
Depreciation
12
Income Statement Approach

• Cash Revenues
• Cost of Goods Sold
• Depreciation
• Operating expense
• Interest expense
• Taxable Income
• Income Taxes
• Income after Taxes
• Depreciation

Net Operating Cash Flow
13
Book Approach
Income Statement
Cash Flow Statement
Net Income Depreciation -Capital
Investment Salvage Proceeds -Gain Tax -Working
Inv Cap Working Cap Recovery Borrowed
Funds -Repayment of Principal
Revenues Expenses Cost of Goods
Sold Depreciation Operating Expenses Taxable
Income Income Taxes Net Income
Operating

Investing

Financing
Assumes Tax Depreciation Book Depreciation
Thus, no deferred taxes
14
(No Transcript)
15
(No Transcript)
16
Inflation

• Economic Analysis
• Chapter 13

17

• Inflation
• A loss in the purchasing power of money over time
• or the same dollar amount buys less of an item
  over time
• Deflation
• prices decrease over time and a specified dollar
  amount gains in purchasing power

General Inflation 5.56 Equiv. Annual raise
5.81
Avg starting salary in 1967 7,500 Avg starting
salary in 1995 36,500
18

• Consumer Price Index
• based on a typical market basket of goods and
  services required by average consumer
• compares the current cost with that 1 month ago,
  1 year ago, 10 years ago
• Base Period used by the Dept of Commerce is 1967
  and the index value is set at 100
• If the market basket of same goods and services
  costs now 455.80, which means the CPI for 1995
  relative to the base period price is 455.8

19

• CPI measures general price increase
• Engineering Economic analysis requires
  appropriate price indices to estimate the price
  increases in raw materials, finished products,
  and operating costs
• Average inflation rate
• inflation rates have a compounding effect

Year 1 IR 4 Year 2 IR 8
Price at the end of the 2nd year
100(10.04)(10.08) 112.32
Avg IR 100(1f)2 112.32
f 5.98
20
Given P114.31 F833.76 1967-95 F
P(1f)N 833.76 114(1f)28
f 0.0735
7.35
General Inflation Rate, fg Based on the CPI for
all items in the market basket Specific
Inflation Rate, fj Based on an index (CPI)
specific to segment j of the economy
21

• Actual (current) dollars, An
• takes into account any anticipated changes in
  amount due to inflationary or deflationary
  effects -- estimate of future CF in year n
• Constant (real) dollars, Ar
• represent constant purchasing power independent
  of the passage of time

22
(No Transcript)
23

• Market Interest Rate (Nominal Interest Rate)
• takes into account the combined effects of the
  earning value of capital (earning power) and any
  anticipated inflation or deflation (purchasing
  power)
• Inflation Free Interest Rate (Real Interest Rate)
• estimates the true earning power of money when
  the inflation effects have been removed.
• Can be computed if the market interest rate and
  inflation rate are known all previous examples

24

• Actual Dollar Analysis
• Deflation Method
• Convert actual dollars into equivalent constant
  dollars by discounting by the general inflation
  rate to remove the inflation effect
• Find the equivalent present worth using the
  inflation-free interest rate
• Adjusted Discount Method
• Deflation and discounting in one step

i' market real interest rate f inflation rate