Statement of cashflow

(using indirect method)

Cashflow from operating activities
• Profit before tax a xxxxx

• Adjustments for:
(These include adjustment for non-cash items)
Depreciation xxx
Amortization xxx
(Gain) / Loss on disposal xxx
Provisions xxx
b xxx
Cashflow from operating activities
• Movement in working capital:

• Decrease / (Increase) in current assets xxx

• (Decrease) / Increase in current liabilities xxx

c xxx

Cash generated from operations (a+b+c=A) XXXXX

Cashflow from investing activities
• Capital expenditure xxxxx
• Proceeds from disposal of fixed assets xxxxx
• Interest received xxxxx
• Dividend received xxxxx
• Investments xxxxx
Cashflow from investing activities B xxxxx
Cashflow from financing activities
• Long term loans obtained xxxxx
• Long terms loan paid off xxxxx
• Dividend paid xxxxx
• Payment of lease liability xxxxx
Cashflow from financing activities C xxxxx
Cash and cash equivalents
• Net increase / (decrease) in cash and cash equivalents (A+B+C) xxx
• Cash and cash equivalents at the beginning of the year xxx
• Cash and cash equivalents at the end of the year xxx
Sample cashflow statement (ICI Annual report 2019)
Sample cashflow statement (ICI Annual report 2019-2020)
Recap from last class on Cash Flow
Statement
• Working capital. Current assets are often called working capital because
these assets “turnover”; that is ,they are used and then replaced through
out the year.
• Net working capital. When a company buys inventory items on credit, its
suppliers, in effect, lend it the money used to finance the inventory items.
It could have borrowed from its bank or sold stock to obtain the money,
but it received the funds from its suppliers, They appear as Account
payable and typically bear no interest. If we subtract the sum of payables
plus accruals from current assets, the difference is called net working
capital.
• Net working capital= Current assets-(Payables +Accruals)
Recap from last class on Cash Flow
Statement
• Depreciation: The charge to reflect the cost of assets used up in the
production process. Depreciation is not a cash outlay.
• Amortization: A noncash charge similar to depreciation except that
it is used to write off the costs of intangible assets.
• EBIT: Earnings before interest, taxes
• EBITDA: Earnings before interest, taxes, depreciation & amortization.
• Cash flow from Operations (Operating activities)
• Cash Flow from Investing Activities
• Cash Flow from Financing Activities
Free Cash Flow: Stock Market & Analyst
Choice
• The most important modifications the concept of free cash flow (FCF),
defined as “the amount of cash that could be withdrawn without
harming a firm’s ability to operate and to produce future cash flows.”
Here is the equation used to calculate free cash flow:
FCF= EBIT(1-T)+Depreciation-{Capital expenditures+Increase in net
working capital}
$283:8(1-0.4)+100-{$230+Change in current assets-Change in payables and
accruals}
= $170.3+$100-($230+($1,000-$810-($200-$160)
= $170.3+ $100-$230-$150 = - $109.7 million
Free Cash Flow
• Note also that most rapidly growing companies have negative FCFs—
the fixed assets and working capital needed to support rapid growth
generally exceed cash flows from existing operations. This is not bad,
provided the new investments are eventually profitable and
contribute to FCF. Many analysts regard FCF as being the single most
important number that can be developed from accounting
statements, even more important than net income.
Time value of Money
• Time value analysis has many applications, including planning for
retirement, valuing stocks and bonds, setting up loan payment
schedules, and making corporate decisions regarding investing in new
plant and equipment. In fact, of all financial concepts, time value of
money is the single most important concept.
• First step in time value analysis is to set up a time line, which will help
you visualize what’s happening in a particular problem. As an
illustration, consider the following diagram, where PV represents
$100 that is on hand today and FV is the value that will be in the
account on a future date.
Time value of Money

• The intervals from 0 to 1, 1 to 2, and 2 to 3 are time periods such as

years or months. Time 0 is today, and it is the beginning of Period 1;
Time 1 is one period from today, and it is both the end of Period 1 and
the beginning of Period 2; and so forth. so forth. Although the periods
are often years, periods can also be quarters or months or even days.
Future Value: Time value of Money
• Future Value: A dollar in hand today is worth more than a dollar to be
received in the future because if you had it now, you could invest it, earn
interest, and end up with more than a dollar in the future. The process of
going to future values (FVs) from present values (PVs) is called
compounding.
• Simple vs Compound Interest: Interest earned on the interest earned in
prior periods, is called compound interest. If interest is not earned on
interest, we have simple interest. The formula for FV with simple interest
is FV=PV+PV(I)(N); so in our example, FV would have been $100+
$100(0.05)(3) = $100+ $15= $115 based on simple interest.
• Simple Interest earned when Interest is not earned on Interest.
Spreadsheet Method of calculating FV
Present Value: Time value of Money
• Formula Approach: To calculate FV of Cash Flow
• Finding a present value is the reverse of finding a future value.
Indeed, we simply solve Equation, the formula for the future value,
for the PV to produce the basic present value Equation,
Present Value: Time value of Money
• A broker offers to sell you a Treasury bond that will pay $115.76 in 3
years from now. Banks are currently offering a guaranteed 5%interest
on 3-year certificates of deposit (CDs);and if you don’t buy the bond,
you will buy a CD. The 5% rate paid on the CDs is defined as your
opportunity cost ,or the rate of return you could earn on an
alternative investment of similar risk.
• The $100 is defined as the present value, or PV, of $115.76 due in 3
years when the appropriate interest rate is 5%. In general, the present
value of a cash flow due N years in the future is the amount which, if
it were on hand today, would grow to equal the given future amount.
Present Value: Time value of Money
Future value of an Ordinary Annuity
• The future value of an annuity can be found using the step-by-step
approach or using a formula, a financial calculator, or a spreadsheet.
As an illustration, consider the ordinary annuity diagrammed earlier,
where you deposit $100 at the end of each year for 3 years and earn
5% per year. How much will you have at the end of the third year?
The answer, $315.25, is defined as the future value of the annuity,
FVAN; it is shown in Table 5-3.
Future Value of an Ordinary Annuity
Future Value of an Annuity Due
• Because each payment occurs one period earlier with an annuity due,
all of the payments earn interest for one additional period. Therefore,
the FV of an annuity due will be greater than that of a similar ordinary
annuity. If you went through the step-by-step procedure, you would
see that illustrative annuity due has an FV of $331.01 versus $315.25
for the ordinary annuity. With the formula approach, we first use
Equation 5-3; but since each payment occurs one period earlier, we
multiply the Equation 5-3 result by (1 +i):
Present Value Ordinary Due
• Because each payment occurs one period earlier with an annuity due,
all of the payments earn interest for one additional period. Therefore,
the FV of an annuity due will be greater than that of a similar ordinary
annuity. If you went through the step-by-step procedure, you would
see that illustrative annuity due has an FV of $331.01 versus $315.25
for the ordinary annuity. With the formula approach, we first use
Equation 5-3; but since each payment occurs one period earlier, we
multiply the Equation 5-3 result by (1 +i):
Present Value Ordinary Due
Present Value Ordinary Due
Uneven Cash Flow
• Uneven (Nonconstant) Cash Flows A series of cash flows where the
amount varies from one period to the next.
• Payment (PMT) This term designates equal cash flows coming at
regular intervals.
• Cash Flow (CFt) This term designates a cash flow that’s not part of an
annuity
Uneven Cash Flow
Future value of uneven cash stream
• We find the future value of uneven cash flow streams by
compounding rather than discounting. Consider Cash Flow Stream 2
in the preceding section. We discounted those cash flows to find the
PV, but we would compound them to find the FV. Figure 5-5 illustrates
the procedure for finding the FV of the stream using the step-by-step
approach.
Future value of uneven cash stream
Future value of uneven cash stream
• Annual Compounding The arithmetic process of determining the final
value of a cash flow or series of cash flows when interest is added
once a year.
• Semiannual Compounding The arithmetic process of determining the
final value of a cash flow or series of cash flows when interest is
added twice a year.
Comparing Interest Rates
• The nominal interest rate (INOM), also called the annual percentage
rate (APR) (or quoted or stated rate), is the rate that credit card
companies, student loan officers, auto dealers, and so forth, tell you
they are charging on loans. Note that if two banks offer loans with a
stated rate of 8% but one requires monthly payments and the other
quarterly payments, they are not charging the same “true” rate—the
one that requires monthly payments is charging more than the one
with quarterly payments because it will get your payment early.
Comparing Interest Rates – Important Points
So to compare loans across lenders, or interest rates earned on
different securities, you should calculate effective annual rates as
described here.
The effective annual rate, abbreviated EFF%, is also called the
equivalent annual rate (EAR). This is the rate that would produce the
same future value under annual compounding as would more frequent
compounding at a given nominal rate.
If a loan or an investment uses annual compounding, its nominal rate is
also its effective rate. However, if compounding occurs more than once
a year, the EFF% is higher than INOM.
Comparing Interest Rates – Important Points
• To illustrate, a nominal rate of 10% with semiannual compounding is
equivalent to a rate of 10.25% with annual compounding because
both rates will cause $100 to grow to the same amount after 1 year.
The top line in the following diagram shows that $100 will grow to
$110.25 at a nominal rate of 10.25%. The lower line shows the
situation if the nominal rate is 10% but semiannual compounding is
use
Comparing Interest Rates – Important Points
Comparing Interest Rates – Important Points

Here INOM is the nominal rate expressed as a decimal and M is the number of compounding periods per year.
In our example, the nominal rate is 10%; but with semiannual compounding, INOM ¼ 10% ¼ 0.10 and M ¼ 2.
This results in EFF% ¼ 10.25%
Pre requisite for a Cash Flow for an
investment decision making
• Cash flow estimation
• Identifying the relevant cash flows
• Tax effect
• Changes in working capital
• Option value
• Adjustment for inflation
Pre requisite for a Cash Flow for an
investment decision making
• Many variables, individuals and departments are involved in cash flow
estimation;
• Financial Staff roles in Cash Flow Forecasting Process
1. Coordination with other departments
2. Ensuring that everyone involved use a consistent set of economic
assumptions
3. Avoiding biases
Pre requisite for a Cash Flow for an
investment decision making
• IDENTIFYING THE RELEVANT CASH FLOWS
• Cash flow versus accounting income
• Timing of cost flows
• Incremental cash flows:
• Sunk cost
• Opportunity cost
• Externalities - effect other projects
Pre requisite for a Cash Flow for an
investment decision making
• TAX EFFECT
a. Accounting and tax depreciation
b. Tax depreciation calculation
c. Sale of depreciable asset
CHANGES IN WORKING CAPITAL
Capital projects often require an additional investment in net working
capital (NWC), which must be included in the project’s cost and then
shown as a cash inflow at the end of the project’s life.
Pre requisite for a Cash Flow for an
investment decision making
• PRINCIPAL TYPE OF CASH FLOWS OVER PROJECT LIFE
a. Investment outlay
b. Operating cash flows
c. Terminal cash flows
• ADJUSTMENT FOR INFLATION – A suggested approach
a. Inflation is critically important therefore it must be recognized and dealt
with
b. Build inflation estimate into cash flows, where relevant
c. Since future inflation cannot be estimated with precision therefore it adds to
uncertainty and complexity
Pre requisite for a Cash Flow for an
investment decision making
• PRINCIPAL TYPE OF CASH FLOWS OVER PROJECT LIFE
a. Investment outlay
b. Operating cash flows
c. Terminal cash flows
• ADJUSTMENT FOR INFLATION – A suggested approach
a. Inflation is critically important therefore it must be recognized and dealt
with
b. Build inflation estimate into cash flows, where relevant
c. Since future inflation cannot be estimated with precision therefore it adds to
uncertainty and complexity
Proposed Project
• Cost: $200,000 + $10,000 shipping + $30,000 installation.
• Depreciable cost $240,000.
• Inventories will rise by $25,000 and payables will rise by
$5,000.
• Economic life = 4 years.
• Salvage value = $25,000.
• modified accelerated cost recovery system (MACRS): 3 years
Proposed Project
• Incremental gross sales = $250,000.
• Incremental cash operating costs =
• $125,000.
• Tax rate = 40%.
• Overall cost of capital = 10%.
Set up without numbers a time line for the
project CFs.
Set up without numbers a time line for the
project CFs.
Incremental Cash Flow
= Corporate cash flow with project
minus
Corporate cash flow without project
• Should CFs include interest expense? Dividends?
- NO. The costs of capital are already incorporated in the analysis
since we use them in discounting. If we included them as cash flows,
we would be double counting capital costs
1. Suppose $100,000 had been spent last year
to improve the production line site. Should
this cost be included in the analysis?

NO. This is a sunk cost. Focus on incremental

investment and operating cash flows.
Suppose the plant space could be leased out for
$25,000 a year. Would this affect the analysis?

• Yes. Accepting the project means we will not receive the $25,000.
This is an opportunity cost and it should be charged to the project.
• A.T. opportunity cost
= $25,000 (1 - T) = $15,000 annual cost.
Net Investment Outlay at t = 0 (000s)
Equipment ($200)
Freight + Inst. (40)
Change in NWC (20)
Net CF 0 ($260)
 NWC = $25,000 - $5,000 = $20,000.
Dep Basis
Basis = Cost
+ Shipping
+ Installation
=$240,000
Annual Depreciation Expense (000s)
Year % Depr. x Basis = Depr.
1 0.33 $240 $ 79
2 0.45 108
3 0.15 36
4 0.07 17
Year 1 Operating Cash Flows (000s)
Year 1
• Year 1 Operating Cash Flows (000s)

Net revenue $125

Depreciation (79)
Before-tax income $ 46
Taxes (40%) (18)
Net income $ 28
Depreciation 79
Net operating CF $107
Year 1 Operating Cash Flows (000s)
Year 1 Year 2
Net revenue $125 $125
Depreciation (79) (17)
Before-tax income 46 108
Taxes (40%) (18) (43)
Net income $ 28 65
Depreciation 79 17
Net operating CF 107 82
Net Terminal Cash Flow at t = 4 (000s)

Salvage value $25

Tax on SV (10)
Recovery on NWC 20
Net terminal CF $35
Project Net CFs on a Time Line

•NPV = $81,573. Rs in “000”

•IRR = 23.8%.
•MIRR = 17.8%.
•Payback = 2.4 years.
S and L are mutually exclusive and will be
repeated. k = 10%. Which one is better?

NPV S = $ 4,132 L = $ 6,190

NPV L > NPV S . But is L better?
Can’t say yet.
Need to perform common life analysis.
• Common life analysis
• Note that Project S could be repeated after 2 years to generate
additional profits.
• Can use either replacement chain or equivalent annual annuity
analysis to make decision.
• Replacement Chain Approach (000s)
Common life analysis
• Project S NPV = $7,547.
• Compare to Project L NPV = $6,190.

• Equivalent Annual Annuity (EAA) Approach

- Finds the constant annuity payment whose PV is
equal to the project’s raw NPV over its original life.
EAA Calculator Solution
ANNUITY
• Project S ANNUITY
=PMT
=PMT**PVIFA
PVIFA10%,
10%,22
• PV = Raw NPV = $4,132. 4132=
4132=PMT
PMT**1.7355
1.7355
• n = Original project life = 2. PMT
PMT=4132
=4132/ /1.7355
1.7355
• k = 10%. PMT=2381
PMT=2381
• Solve for PMT = EAA S = $2,381.
• Project L
• PV = $6,190; n = 4; k = 10%.
• Solve for PMT = EAA L = $1,953
Equivalent Annual Annuity (EAA)
• The project, in effect, provides an annuity of EAA.
• EAA S > EAA L so pick S.
• Replacement chains and EAA always lead to the
same decision if cash flows are expected to stay the
same.