Analysis of Project Cash

flow
By Dr Sharon K Jose
 Cash flow Estimation
• At this stage, we need to define the stream of cash flow (both inflows and
outflows associated with the project).
 Analysis of project cash flow principles
• The cost and benefits of all costs must be measured in terms of cash flow basis. This
implies that all the non-cash charges for expenses like depreciation which are considered
for purpose of determining the profit after tax must be added back to arrive at the net cash
flow for a purpose.
•  Consider only relevant cash flow of the firm. 
• Interest on long term loan must be included for determining the net cash flow. The net cash
flows are defined from the point of view of suppliers of long term funds.
•  The cash flow must be measured in incremental terms
•  Sunk costs must be ignored opportunity cost associated with the project must be considered
Practice Problem

The project has an expected life of 10 years

 Plant and machinery will depreciate at a rate of 33.33 % forerunner on written down value method.
The expected annual sales will be rupees 80 lakh and the cost of sales (including depreciation but it excluding interest) is
expected to be rupees 50 lakhs.

Plant machinery rupees 36 Lakhs 

Working capital   rupees 24  Lakhs
The proposed scheme of
financing is as follows
Equity capital rupees 16  Lakhs
Term loan rupee 26  Lakhs
Trade credit rupees 8  Lakhs 
Working capital advance rupees 10 Lakhs 
• The term loan interest rate 14% which is repayable payable in five equal
instalments beginning from the end of the first year.
• Working capital advances carry an interest of 17 % 
• Define the cash flow for the first three years from the long term fund point of
you.
• Tax 50%
 #Note on Investment outlay
• The investment outlay as to be considered from the point of view of
suppliers of long term fund in the given example we find that (8+10) 18
lakhs out of the investment of 24 lakhs in working capital is financed by
way of trade credit and working capital advance. 
• Working capital margin =24-18=6
• Investment =P&M +6=36+6=42 lakhs
 Year 0 1 2 3
Investment (42)
Sales 80 80 80
Operating Cost (excluding dep) 38 42 44.67
Depreciation 12 8 5.33
50 50 50
Interest on working capital 1.70 1.70 1.70
advance
Profit before tax 28.30 28.30 28.30
Tax 14.15 14.15 14.15
PAT 14.15 14.15 14.15
Initial flow (42) (PAT+DEP)
26.15 22.15 19.45
Net cash flow (42) 26.15 22.15 19.45
If the WACC is 10% find NPV?
 Cash flows associated with replacement decision

• Sandals Inc is considering the purchase of a new leather cutting machine to replace an existing
machine that has a book value of rupees 3000 and can be sold at rupees 1500
• The new machine will reduce cost by rupees 7000 this will be the cash savings over the old machinery.
•  The new machinery level will have four your life and cost rupees 14000 and can be sold for an
unexpected amount of rupees 2,000 at the end of the fourth year.
• Assume in straight-line depreciation and a 40% tax rate define the cash flow associated with the
investment assume that the straight-line method of depreciation is used for tax purposes
 Working note computation of depreciation:

•  Old leather cutting machine Rs. 3000 divided by 4 yours =3000/4=750

•  new leather cutting machine rupees 12000,4 years=12000/2=Rs.3000
•  incremental depreciation=Rs.3000-750 =Rs.2250
 Year 0 1 2 3 4
1 New investment (12500)
in New Machine

2 Saving Cost 7000 7000 7000 7000

3 Incremental 2250 2250 2250 2250

depreciation
4 Pre tax profit 4750 4750 4750 4750

5 Taxes 1900 1900 1900 1900

6 PAT 2850 2850 2850 2850

7 Inflow (12500)
8 Operating flow 5100 5100 5100 5100

9 Terminal flow 2000

10 Net cash flow (12500) 5100 5100 5100 7100
(7)+(8)+(9)