Estimation of Cash Flows

Principles should be applied during Estimation of Cash Flows

• Cash Flows should be measured on an Incremental Basis.

• Cash Flows should be measured on an after-tax basis.
• All the indirect effects of a project should be included in the Cash Flow
calculations.
• Sunk costs should not be considered when evaluating a project.
• The value of resources used in a project should be measured in terms of
their opportunity costs.
Determination of Cash Inflows: Single Investment Proposal (t = I - n)
Particulars Years
1 2 3 4
… n
Cash Sales Revenues
Less: Cash Opening Cost
Cash Inflows Before Taxes (CFBT)
Less: Depreciation
Taxable Income
Less: Tax
Earning After Tax
Plus: Depreciation
Cash Inflows after tax (CFAT)
Plus: Salvage Value (in nth year)
Plus: Recovery of Working Capital (in nth year)
Cash Outflows of New Project [Beginning of the Period at
Zero Time(t=0)]
1. Cost of New Project
2. + Installation cost of plant and equipments
3. + Working Capital Requirements
 Terminal Value
Terminal value (TV) is the value of a business or project beyond the forecast period
when future cash flows can be estimated. Terminal value assumes a business will
grow at a set growth rate forever after the forecast period. Terminal value often
comprises a large percentage of the total assessed value.
• Terminal value (TV) determines a company's value into perpetuity beyond a set forecast
period—usually five years.
• Analysts use the discounted cash flow model (DCF) to calculate the total value of a
business. DCF has two major components—the forecast period and terminal value.
• There are two commonly used methods to calculate terminal value—perpetual growth
(Gordon Growth Model) and exit multiple.
• The perpetual growth method assumes that a business will continue to generate cash
flows at a constant rate forever, while the exit multiple method assumes that a business
will be sold for a multiple of some market metric.