Project Evaluation Principles

 Incremental Cash flows=) Decision should be based on

the incremental cash flows
 Sunk cost=) Ignore the Sunk costs associated with new
projects
 Externality=)
o If positive =) then ignore
o If negative =) adjustment required
 Taxes =) we consider after tax cash flows
 Finance cost =) reflected in discount rate
o A=L+E
 Opportunity cost =) cost will be added in project costs, e.g.
usage of old photocopier machine in the new project

Project Cash flows

 Initial Cash flows = at year 0
o FCInv + W.CInv.
 Operating cash flows =) at Years 1-5
o ((S – F.C - V.C) – Dep)*1-t + Dep
o (S – F.C - V.C)*1-t + (Dep*t)
 Terminal cash flows =) at year 5
M.V + W.CInv – (M.V – R.B.V)*t
 Remaining book value
Expected Market Value

Suppose you bought a car of PKR 2 million 5 years ago,,, and you
depreciated with an expectation of Remaining book value of PKR 1
million =) so Remaining book value = 1 million

Depreciation =) EBT

1 2
EBITDA 100 100
Dep 30 0
EBIT 70 100
Int. 0 0
EBT 70 100
Tax 30% 21 30
Dep Difference 9 =) Dep Tax Shield

D*t = 30*0.3 = 9
R&D = 750,000 =) sunk cost and it is ignored
Market surveys = 200,000 =) sunk cost and it is ignored

V.C = 185
F.C = 5,300,000 per year
Initial Cash Flow= 38,500,000 + 7,700,000
FCInv = 38,500,000
NWCinv = 7,700,000
Years Volume Price Sales V.C F.C Dep

1 74,000 480 35,520,000 13,690,000 5,300,000 5501650

2 95,000 480 45,600,000 17,575,000 5,300,000 9428650

Terminal Cash Flow = M.V + W.CInv – (M.V – R.B.V)*t

5,400,000 + 7,700,000 – (5,400,000 - 8,589,350)*0.35

Externality working =) you need to calculate total sales of previous project for 2 years in following cases:
 If new project does not launch
 If new project launches

After then you will have to subtract both cash flows=) the difference will be the Side Effect or Externality