fm 100 cash flow analysis

7/28/2019 FM 100 Cash Flow Analysis

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Cash Flow Analysis


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Cash flow analysis deals withthe timing and amount of cashinflows/outflows from a firm or

an investment

There is an old saying in Finance:Cash, not profit is king.


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General Overview

Types of Analysis

Cash Flows in Capital BudgetingComprehensive Example


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Profits and cash flows are very differentthings

Profits under the accounting systemare calculated on accrual basis ratherthan cash basis


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As an investor much better to look atboth Income Statement and theStatement of Cash Flows

As management, very important toanalyze the different types ofinflows/outflows for capital budgeting

decisions


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Statement of CF Analysis

Free Cash Flows

Payback Period

Net Present Value

Internal Rate of Return


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Cash Flow from OperatingActivities

Cash Flow from InvestingActivities

Cash Flow from FinancingActivities


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Operating Income (Earning before interest andtaxes)

+Depreciation

= EBITDA (Earnings before interest, taxes,

Depreciation, and amortization)

- cash tax payments

= after-tax cash flows from operations


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A portion of the costs of fixed

assets charged against annualrevenues over time.

Depreciable life: Time period overwhich an asset is depreciated.

Depreciation Methods:

a) Straight-line methodb) Double-declining balance

c) Sum-of-the-years-digits


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Book value represents the remaining, capitalinvestment (not yet depreciated) on the booksafter the total amount of depreciation charges (to

date) have been subtracted from the basis. Thebook value (BV) is usually determined at the endof each year.

Market Value (MV) is the amount realized from

sale on the open market. Salvage Value (S) is the estimated trade-in value

or market value at the end the assets useful life.


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Important Terms First Cost or Unadjusted Basis (B)

Initial purchase price + all costs incurred in placingthe asset in service Recovery Period (n)

Depreciable life of the asset in question often setby law

Depreciation Rate (dt) The fraction of the first cost removed by

depreciation each year Personal Property

All property except real estate used in the pursuit ofprofit or gain

Real Property Real estate and improvements, buildings and

certain structuresLand is Real Property, but by law is NOT depreciable for tax purposes


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a)Straight-line method Original Cost

Salvage Value * (1/life) * (#/12)

b)Double-declining balance Depreciation Base * (2 * 100% / Useful Life of Asset in Years)

c)Sum-of-the-years-digits


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Visionary Corporation acquired acomputer set amounting $5,000computer with a $200 salvage

value and an estimated useful lifeof three years.

Calculate the depreciation using:a) Straight lineb) Double-declining balancec) Sum-of-the-years digits


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A criteria used in capitalbudgeting. Defined as the

number of years required torecover initial cashinvestment


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250,000.00

Payback

Year 1 165,000.00 1

Year 2 75,000.00 1

Year 3 15,000.00 1

Year 4 0 0.3

Year 5

Payback 3.3

60,000.00

50,000.00

50,000.00

It will take 3 years to recover 235,000 and the .3 of the 4th year to

recover the remaining 15,000. Therefore the payback in this example

is 3.3.

Initial Investment in project

85,000.00

90,000.00

Cash inflows after-tax


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In simple terms NPV is the sum ofdiscounted cash inflows from aproject- the projects initial outlay

If NPV is > 0 accept else reject


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Stars Stadium is considering purchasing vending

machines with a 5-year life and salvage value of P50,000.Cost of Capital is 15%.

Cost and revenue information

Cost of vending machines 750,000

Revenue 843,750

Cost of goods sold 506,250

Gross profit 337,500

Cash operating costs 33,500

Depreciation 140,000 173,500Pretax income 164,000

Income tax 64,000

After-tax income 100,000

(P750,000 - P50,000) 5 years

Net Present Value Approach


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Discount rate that equates thepresent value of inflows with

the present value of outflows. Insimple terms it reflects the rateof return for a project


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Assuming that a hospital has theopportunity to invest P205,570.50 in anew ultrasound system that willproduce net cash inflows of P50,000 at

the end of each of the next six years.

Required:

Calculate the IRR for the ultrasoundsystem.


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Formula: df=I/CF

df= 205,570.50 / 50,000

= 4.11141 (refer to the PVIFA Table)

Therefore: IRR = 12%


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Capital budgeting is the decisionmaking process through whichfirms decide which projects get

the funding Financial plans for most firms are

based on the capital budgeting

analysis using cash flows


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Use Free Cash Flows Ratherthan accounting Profits

Only worry about incrementalCash Flows

Cash Flow diversion from other

Product Categories


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Look for Incidental or SynergisticEffects

Working-Capital Requirements

Incremental Expenses

Opportunity Costs


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Cost of new plant and Equipment 9,700,000.00

Other Costs 300,000.00

Total Cost 10,000,000.00

Total Unit Sales Year Sold

1.00 50,000.00

2.00 100,000.00

3.00 100,000.00

4.00 70,000.00

5.00 50,000.00

Sales price per unit 150.00

Variable cost 80.00

Fixed Costs 500,000.00

Required Working Capital 100,000.00

Depreciation 2,000,000.00

We just added the total costof plant with other costs anddivided it by 5 years to get a

straight line decpreciation.

This example is something similar to what many firmswould deal with in the real world. We will first deriveFree Cash Flows and then apply the NPV and IRR

techniques that we learned earlier.


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STEP 1

Year 0 1 2 3 4 5

Units Sold 50,000.00 100,000.00 100,000.00 70,000.00 50,000.00

Sale Price 150.00 150.00 150.00 150.00 150.00

Sales Revenue 7,500,000.00 15,000,000.00 15,000,000.00 10,500,000.00 7,500,000.00

Less: Variable Costs 4,000,000.00 8,000,000.00 8,000,000.00 5,600,000.00 4,000,000.00

Less: Fixed Costs 500,000.00 500,000.00 500,000.00 500,000.00 500,000.00EBDIT 3,000,000.00 6,500,000.00 6,500,000.00 4,400,000.00 3,000,000.00

Less: Depreciation 2,000,000.00 2,000,000.00 2,000,000.00 2,000,000.00 2,000,000.00

EBIT 1,000,000.00 4,500,000.00 4,500,000.00 2,400,000.00 1,000,000.00

Taxes (@ 34%) 340,000.00 1,530,000.00 1,530,000.00 816,000.00 340,000.00

EBIT, TAXES and DEPRECIATION are calculated here

In this example we've calculated EBIT along with taxes that we will use to derive Operating Cash Flow on thenext slide. We subtract depreciation here so we can pay less taxes. The depreciation will be added back in thenext step as it is a non-cash item.


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STEP 2

Year 0 1 2 3 4 5

EBIT 1,000,000.00 4,500,000.00 4,500,000.00 2,400,000.00 1,000,000.00

Minus: Taxes 340,000.00 1,530,000.00 1,530,000.00 816,000.00 340,000.00

Plus:Depreciation 2,000,000.00 2,000,000.00 2,000,000.00 2,000,000.00 2,000,000.00Operating Cash Flows 2,660,000.00 4,970,000.00 4,970,000.00 3,584,000.00 2,660,000.00

Operating Cash Flows

Depreciation is added back here as we move toward Free cash flows. Here

Operating Cash Flows are derived.


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STEP 3

Year 0 1 2 3 4 5

(100,000.00) 100,000.00

Working Capital Needs

In this example we have an initial outflow ofworking capital that is recouped completely in the

last year at the termination of the project. So inyear one we subtract it and add it back in year 5.


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STEP 4

Year 0 1 2 3 4 5

Operating Cash Flow 2,660,000.00 4,970,000.00 4,970,000.00 3,584,000.00 2,660,000.00

Less: Net work ing capital (100,000.00) - - - - 100,000.00

Less: Initial Outlay (10,000,000.00)

Free Cash Flow (10,100,000.00) 2,660,000.00 4,970,000.00 4,970,000.00 3,584,000.00 2,760,000.00

Free Cash Flo w

Finally we have the free cash flows that we can use in our NPV and IRRcalculations.


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Now, using the date calculate the NPV and the IRR for the Project

Initial Outlay (10,100,000.00)

Cash inflows/Year 0 1 2 3 4 5

2,660,000.00 4,970,000.00 4,970,000.00 3,584,000.00 2,760,000.00

Depending on the answer also recommend if the project should be accepted.


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Year 0 1 2 3 4 5Not Discounted 2,660,000.00 4,970,000.00 4,970,000.00 3,584,000.00 2,760,000.00

Discounted 2,418,181.82 4,107,438.02 3,734,034.56 2,447,920.22 1,713,742.85

Initial Outlay (10,100,000.00)

Required Rate 10.00%

NPV 4,321,317.47

Several ways to do so, first you can get the discounted cashflowsfor each year and then add all of them up along with the initialoutlay. A simple way is to use the NPV function in excel. This is

positive so we should go ahead with the project.

This rate depends on the firms required rate of return. Its dependent on differentfactors which we can't get into in this presentation. But most firms do have agiven required rate of return for their projects.


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Year 0 1 2 3 4 5

Not Discounted (10,100,000.00) 2,660,000.00 4,970,000.00 4,970,000.00 3,584,000.00 2,760,000.00

IRR 26%

Note that IRR is best solved for with a financial calculator or using a spreadsheetro ram. Here the excel function for IRR was used to come u with this value.

fm 100 cash flow analysis

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