INVESTMENT PROJECTS EVALUATION

Miguel Carvalho
miguel.carvalho@mitportugal.org
 Tópicos da apresentação

Present Value Cash Flow Investment Sensitivity

of money Project Analisys
Valuation

Summary
 Present value of money

What is preferable, to receive 1.000 € NOW or 1.150 € in 2 years?

Present Value of Money

What is preferable, to receive 1.000 € NOW or 1.150 € in 2 years?

Discount Rate
r = 10%

1.000 x (1+10%)2
1.210 €
1.000 x (1+10%)
1.100 €
1.000 € Present Value (PV)

1.210 €
2
= 1.000 €
1 + 10%

0 1 2
Cash-Flow

What is a Cash Flow?

 New Ventures – Typical cash In-flows and Out-flows

INVESTORS DEBT

PROJECT
INTERESTS
RE-INVEST CASH-FLOW Banks
Investors

DIVIDENDS
TAXES
Equipments, people
STATE
sub-contracts, Etc…
 Balance Sheet, Profit and Losses and Cash-Flow

Profits and Losses Statement - History

Balance Sheet - Present
Measures and Reports Profit generated
A snapshot of the value of a company in
during a certain period
a certain point in time
Profit/Loss is an opinion based on
Statement of Assets and Liabilities
accounting Principles

Cash Flow

Statement showing cash generation

(inflow) and cash usage (outflow)
Balance Sheet

ASSETS EQUITY
ASSETS SHARE CAPITAL
• Tangible RESERVES
• Intangible RETAINED PROFITS
ACCOUNTS RECEIVABLE NET PROFIT
CASH AND BANKS ...
...

LIABILITIES
M/L TERM LIABILITIES
CURRENT LIABILITIES
...
ASSETS = EQUITY + LIABILITIES
Profit & Losses Statement

Simplified Income Statement

1 Revenues
• Sales of Goods and products
• Services
2 Operational Costs
• Outsourced Services
• Labor cost
3 Financial Costs
4 Depreciation
5=1–2–3–4 Gross Results
6 Taxes
7=5–6 Net Results
 Depreciation
They represent the wear and tear that you give to a determined asset during its lifecycle period

Depreciation represents an accounting cost but does not represent a cash outlfow => they have
impact on the Net Results through the fiscal impact

Example:
You buy 1 Computer to use 1.500€
In Project AAAAA

Typical Depreciation rate for computers

33,33%  1/33,33% = 3 Years

Project AAAAA (Duration 3 years)

Asset value 1.500€ 1.000€ 500€ 0€
Depreciation 500€ 500€ 500€

Year 1 Year 2 Year 3 Year 4

Depreciation (2)
Decreto Regulamentar nº 25/2009 - Typical depreciation taxes

Tipo de bens (%) Anos

Edifícios e outras construções: Edíficios industriais 5,00% 20
Comerciais e administrativos 2,00% 50
Equipamentos de uso Oficinas: Carpintarias 12,50% 8
geral: Serralharias 14,28% 7
Máquinas - Ligeiras 20,00% 5
ferramentas: Pesadas 12,50% 8
Aparelhagem e máquinas electrónicas 20,00% 5
Aparelhos de laboratório e precisão 14,28% 7
Equipamento de escritório (p.e.:
20,00%
fotocopiadoras) 5
Mobiliário 12,5% 8
Computadores 33,33% 3
Programas de computador 33,33% 3
Aparelhos telemóveis 20,00% 5
Veículos automóveis: Ligeiros e mistos 25,00% 4
Pesados de passageiros 14,28% 7
Pesados e reboques, de mercadorias 20,00% 5
Cash Flow

Cash Flow = Cash Inflows – Cash Outflows

CASH-FLOW
1 Investments
2 Revenues
3 Operational Costs
4 Financial Costs
5 Depreciation
6=2–3–4–5 Gross Results
7 Taxes
8=6–7 Net Results
9=-1+8+5 CASH-FLOW
Lets stop and think for a while on a possible example

Imagine that you are about to start a new business venture in form of a low-cost gourmet restaurant in
Lisbon.

To launch your new venture from the searches that you have made you will need to acquire kitchen
equipment, furniture, a payment machine and also all the other needed services (electricity, water, etc.)
and also the human resources needed.

Please think on the following items:

• Investments
What are the necessary investments we need to make to launch this venture?

• Costs
What are the different costs that we may incur on this activity.

• Revenues
What can we do in order to estimate revenues?

• Market factors
What market factors should we Look at? What can originate an increase or decrease on revenues?
 Yearly Cash-Flow Calculation (Example)

YEARS
0 1 2 3 4 5 6 7 8
INVESTMENT (CAPEX) 80.000

REVENUES 263.013 283.801 308.168 329.375 353.064 360.125 363.726 363.726

EXEPENSES 256.155 270.509 287.263 301.923 318.257 322.964 325.365 325.365

Materials 175.342 189.201 205.446 219.583 235.376 240.083 242.484 242.484
Personnel Costs 61.504 61.504 61.504 61.504 61.504 61.504 61.504 61.504
External Services 19.309 19.804 20.314 20.836 21.377 21.377 21.377 21.377

EBITDA (1) 6.858 13.293 20.905 27.452 34.807 37.161 38.361 38.361

DEPRECIATION 14.792 14.792 14.792 13.125 13.125 3.125 3.125 3.125

GROSS RESULT -7.933 -1.499 6.113 14.327 21.682 34.036 35.236 35.236
TAX (2) 23% 0 0 1.406 3.295 4.987 7.828 8.104 8.104
NET RESULTS -7.933 -1.499 4.707 11.032 16.695 26.208 27.132 27.132

CASH-FLOW -80.000 6.858 13.293 19.499 24.157 29.820 29.333 30.257 30.257

(1) EBITDA - Earnings before interest, taxes, depreciation, and amortization

(2) Tax – Assuming a simplification that 25% of gross results are taxed
Present value of a Cash Flow

PV = - C0 + C1/1+r + C2/(1+r)2 + C3/(1+r)3 + C4/(1+r)4

CF0 CF4

CF2
CF1 CF3

PV
𝑛
𝐶𝐹𝑖
𝑃𝑉 = −𝐶𝐹0 + 𝑖
1+𝑟
𝑖=1
 Present value of a Cash Flow

ANOS
0 1 2 3 4 5 6 7 8

CASH FLOW -80.000 6.858 13.293 19.499 24.157 29.820 29.333 30.257 30.257
PV CFi -80.000 6.235 10.986 14.650 16.499 18.516 16.558 15.527 14.115
Accum. Cash Flow -80.000 -73.765 -62.780 -48.130 -31.630 -13.114 3.443 18.970 33.085
NPV 33.085

Discount rate ( r ) = 10%

𝟐𝟒. 𝟏𝟓𝟕
Present Value (Year 4) = = 16.499
𝟏 + 𝟏𝟎% 𝟒

𝑛
𝐶𝐹𝑖
𝑉𝐴 = −𝐶𝐹0 + 𝑖 = 33.085
1+𝑟
𝑖=1
Evaluation of an
Investment Project

What criteria should be met when investing on a

certain project
 Project Evaluation in 3 steps

• Forecast the expected Cash-Flow (after taxes) released by the project.

• Estimate the opportunity cost of capital – r (it reflects the time value of money and the risk
involved).

• Calculate NET PRESENT VALUE, INTERNAL RATE OF RETURN and PAY-BACK PERIOD.

Accept project if:

NET PRESENT VALUE INTERNAL RATE OF RETURN
• Accept if NPV > 0 • Accept if IRR > r
• Reject if NPV < 0 • Reject if IRR < r
Internal Rate of Return
ANOS
0 1 2 3 4 5 6 7 8
CASH FLOW -80.000 6.858 13.293 19.499 24.157 29.820 29.333 30.257 30.257
IRR 18,36%

50.000

r NPV(€) 40.000 TIR

8% 43.763 30.000 ≈
10% 33.085 18,36%
NPV 20.000
12% 23.640
(€) 10.000
14% 15.258
16% 7.797 0
18% 1.135 -10.000
20% -4.831
22% -10.189 -20.000

Discount Rate ( r )
• IRR represents the maximum return rate of the project.
• It is the Discount rate that makes NPV = 0.
Pay-back time
It is the period of time that takes to recover accumulated discouted cash-flows
Discount rate

𝒓= 𝟏 + 𝑻𝟏 . 𝟏 + 𝑻𝟐 . 𝟏 + 𝑻𝟑 -1

T1 – Own Capital cost

• A good base can be the utilization of historic values of treasure bonds as they (tipically)
represent a no-risk return rate

T2 – Risk Prize
• Quantifies the inherent project (example: the associated risks of a restaurant is different
than that associated to a biodiesal plant)
• Depends on the kind of project, market, etc…

T3 – Inflation
• Always be coherent while treating inflations
 Inflation
Constant vs. Current Prices
Discount rate
CONSTANT PRICES 𝒓= 𝟏 + 𝑻𝟏 . 𝟏 + 𝑻 𝟐 . 𝟏 + 𝑻𝟑 -1
Own Capital Cost– 4,762%
Risk Prize – 5%
Discount rate – 10,0% ANOS
0 1 2 3 4 5 6 7 8
CASH FLOWS -80.000 6.858 13.293 19.499 24.157 29.820 29.333 30.257 30.257
PV Cfi -80.000 6.235 10.986 14.650 16.499 18.516 16.558 15.527 14.115
NPV 33.085

CURRENT PRICES
Own Capital Cost– 4,762%
Risk prize – 5%
Inflation – 2 %
Discount rate – 12,2% ANOS
0 1 2 3 4 5 6 7 8
CASH FLOWS -80.000 6.995 13.830 20.692 26.148 32.924 33.033 34.756 35.451
PV Cfi -80.000 6.235 10.986 14.650 16.499 18.516 16.558 15.527 14.115
NPV 33.085
Perpetuity or Residual Value

Residual Value (RV)

Accounting value at the end of the project

Perpetuity
𝐶𝐹𝑇+1
𝑅𝑉 =
Anuidades crescentes e perpétuas 𝑘𝑛 − 𝑔𝑛

𝐶𝐹𝑇+1
Anuidades constantes e perpétuas 𝑅𝑉 =
𝑘𝑛
1 1
𝑅𝑉 = − 𝑛−𝑇 𝐶𝐹𝑇+1
Anuidades constantes e finitas 𝑘𝑛 𝑘𝑛 1 + 𝑘𝑛

Anuidades crescentes e finitas

1 + 𝑔 𝑛−𝑇
1 1 + 𝑘𝑛
𝑅𝑉 = − 𝐶𝐹𝑇+1
𝑘𝑛 − 𝑔 𝑘𝑛 + 𝑔𝑛
K – Cost of Capital
G – Cash-Flow growth rate
4 Sensitivity Analysis

What if the revenues are lower than expected?

 Sensitivity Analisys

What if the Investment is higher than expected?

Δ NPV
Invest. (%) (€)
25% 14.986
20% 18.605
15% 22.225
10% 25.845
NPV
5% 29.465
(€)
0% 33.085
-5% 36.705
-10% 40.325
-15% 43.808
-20% 47.287
-25% 50.766

% variation on investment value

Even with an increase of 25% on the investment needed the project would still be able to
demonstrate a positive NPV.
Sensitivity Analisys

What if revenues are lower than expected?

Δ NPV
Reven. (%) (€)
10% 78.893
8% 69.928
6% 60.788
4% 51.649
NPV
2% 42.509
(€)
0% 33.085
-2% 23.586
-4% 14.087
-6% 4.579
-8% -5.275
-10% -15.129

% variation in the ammount of

meals served
If sales decrease by more than 8% the NPV becomes negative so we may eventually need to look at
the sales forecasts with a bit more attention or develop alternative strategies in case this occurs.
Scenario Analysis

You should always prepare a couple of scenarios

Beyond sensitivity analysis that allows the variation of 1 or more variables, you
should also create possible project development scenarios to analyze the final
outcome if severall variables are changed simultaneously.

PESSIMIST SCENARIO REGULAR SCENARIO OPTIMIST SCENARIO

5 Summary

Main concepts to retain

Cash-Flow forecasts: cautions to have (1)

Depreciation is not a Cash-Flow but it affects taxes.

Do not forget investments that are needed along the project life-cycle.

Separate investment and financing decisiosn (do the analysis as if the project
was totally funded by own capital).

Carefully analyse:
1. sunk costs
2. Externalities (the effects that the project may have in the remaining
operations of the company)
3. Opportunity costs.
4. General costs
Cash-Flow forecasts: cautions to have (2)

Do not Forget of the Residual Value of the Project

1. Liquidation Value: it is necessary to estimate the sale of assets from the
project and other additional costs (recuperação do investimento em
NOF, poupanças fiscais associadas a menos-valias, etc.)
2. Perpetual growth (or not): Assume that the Cash-Flows will grow at a
certain growth rate

Be consistent with the treatment of inflation

1. Analysis at current costs (all cash-flows will include expected
inflation) – use a discount rate at nominal terms.
2. Analysis at constant prices – use a discount rate at real terms.
References

Princípios de Finanças Empresariais, Richard A. Breadley, Stewart C. Myers, McGraw Hill

Princípios de Gestão Financeira, H. Caldeira Menezes, Editorial Presença

Decisões de investimento - Análise Financeira de Projectos, Isabel Soares, José Moreira,

João Couto, Edições Sílabo

Avaliação de empresas e Negócios, João Carvalho das Neves, McGraw Hill

 INDUSTRIAL ECOLOGY

INVESTMENT PROJECTS EVALUATION

Miguel Carvalho
miguel.carvalho@mitportugal.org
Wind Atlas