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Cash Flow Estimation
Cash Flow Estimation
Financial Management
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
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
Points of Consider
Sunk Costs Opportunity Costs Project Externalities Change in Net Working Capital
Sunk Costs
Sunk CostsA cost that has already been incurred and cannot be recovered irrespective of the decision to accept or reject the project. R&D, Market Research, Consultants Fees Is it relevant or irrelevant?
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?
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?
Sales Revenue minus Total Costs = Earnings Before Interest and Taxes (EBIT)