The characteristics of an investment are the volume of the initial expenditure and the spread

of operating receipts and disbursements over several years.

Assessing its profitability therefore involves calculating annual net cash flows, using
discounting techniques and integrating the financing method.

1. The concept of investment

A Calculating cash flows

Any investment results in receipts and disbursements over several years:

- collections: this is the expected additional turnover
- disbursements: these are additional expenses linked to the investment so this
includes the investment itself, personal expenses
additional costs, equipment maintenance, etc.
Net cash flow therefore corresponds to the difference between receipts and
disbursements, which is therefore called “cash flow”. At the beginning, disbursements
exceed receipts and cash flows are negative.
Subsequently, they become positive. The profitability of the investment must
therefore be assessed over the entire lifespan of the investment.
Please note, not all investment-related charges correspond to disbursements.

= net cash flow

 0 1 2 3 4
- 1M
250,000
290,000
450,000
450,000

2. Updating
We would rather receive €100 today than €100 in a year. This means that the same
amount does not have the same value over time.
Discounting is a technique for reducing amounts received in the future to amounts
received today in order to make them comparable. To discount, we use a discount rate
which represents the price of time.
a) The case of any cash flows
The present value of a sum Cn received in n year is equal to: C0 = Cn(1+i)^-n

C: capital / i: interest

 calculation of discounted flows

 0 1 2 3 4
 -1000 227,27 239,67 338,09 307,36

b) Constant cash flows

When the cash flows are identical, the total net present value of all the cash flows affected
from period 1 until period n is given by the following formula :

V0=ax 1-(1+i)^- n
i
frExample :
An investment gives cash flows of €3,000/year for 4 years. The present value of all cash flows
at t=0 (one period before the first) is equal to

V0 = 3000 x 1 - (1.1)-4 / 0.1 = 9,509.60. This figure represents the value of 4 positive cash
flows of €3,000 discounted at t=0.

2) The profitability of an investment

We have several criteria to evaluate the profitability of an investment.
1. Recovery time
The payback period for invested capital indicates how long it takes for the company to
recover the capital initially invested.

We calculate the cumulative net cash flows

 0 1 2 3 4
 -1000 227,27 239,67 338,09 307,36
 -1000 -772,73 -533,06 -194,97 112,39

X=(194,97*360)/307,36
X=228,36
So the recovery time is 3 years, 7 months and 18 days.