Initial outlay

5 – Cash Annual after-tax

Flows operating cash
flows
projections

Terminal year
after-tax non-
operating cash
flows

Quyen Nguyen, PhD - FBF - FTU 58

5 – Cash Flows projections

• Initial outlay
For a new investment:
Outlay = FCInv + NWCInv
Where:
FCInv : Investment in net fixed capital
NWCInv : Investment (variation) in net working capital

Quyen Nguyen, PhD - FBF - FTU 59

5 – Cash Flows projections

• Annual after-tax operating cash flows

CF = (S – C - D)(1- T) + D – NWCInv
Or
CF = (S – C) (1- T) + T*D – NWCInv
Where:
S : Sales
C : Cash operating expenses
D : Depreciation charge
T : Tax rate
Quyen Nguyen, PhD - FBF - FTU 60
 5 – Cash Flows projections
Terminal year after-tax non-operating cash flows

Quyen Nguyen, PhD - FBF - FTU 61

5 – Cash Flows projections

§ Investment in fixed capital: 10,000

§ Straight line depreciation to zero over 5 years
§ Length: 5 years
§ Annual Sales: 10,000
§ Cash operating expenses: 4,000
§ NWCInv: 1,000 beginning at t = 0 to t = 5
§ Required rate of return: 10%
§ Tax rate: 33 1/3%

Quyen Nguyen, PhD - FBF - FTU 62

Example

Quyen Nguyen, PhD - FBF - FTU 63

Example

Quyen Nguyen, PhD - FBF - FTU 64

NPV Example

Quyen Nguyen, PhD - FBF - FTU 65

 Example

You have to decide to invest or not for an expansion project. The project has an
expected 5 years life.
We assume that sales will be equal to $55,000 each year, variable cash operating
expenses $18,000 ; and fixed operating expenses $24,000. Fixed operating expenses
contain depreciations.
We consider an investment outlay of $100,000 concerning fixed capital items that will
be depreciated straight-line to zero over five years.
We assume an annual investment in net working capital to t = 0 to t = 5 of $5,000.
The expected after-tax salvage value is equal to $6,000.
The tax rate is equal to 34%.
1°) Determine the cash flows.
2°) The expected rate of return is equal to 10%. What is the project NPV?
3°) The IRR is equal to 12.14%. Is it compatible with the decision given by the NPV?
Why?
Quyen Nguyen, PhD - FBF - FTU 66
 Cash flows for a replacement
project
§ Incremental cash flows
⇒ the CF the company realizes with the investment compared to the CF the
company would realize without the investment.

⇒ The terminal year after-tax non operating cash flow:

Quyen Nguyen, PhD - FBF - FTU 67

Cash flows
for a
replacement
project

§ If the new equipment replaces the old equipment, an additional investment of

$80,000 in net working capital will be required.
§ Tax rate = 30%
§ Required rate of return: 8%

Quyen Nguyen, PhD - FBF - FTU 68