After-Tax Cash Flow

In modern methods of profitability assessment, cash flows are more meaningful than profits, which tend to be rather loosely defined. The net annual cash flow after tax is given by... 

FIG. 9-1 Relationship between annual costs, annual profits, and cash flows for a project. A d — annual depreciation allowance Acf — annual net cash flow after tax Ac/ = annual cash income Age = annual general expense Aqp = annual gross profit A/r = annual tax A e = annual manufacturing cost Avc/ = annual net cash income Avvp = annual net profit after taxes A/ p = annual net profit As = annual sales Apc = annual total cost (DCFRR) = discoiinted-cash-flow rate of return (NPV) = net present value. 

At the end of Year 10, the working capital (C vc = 90,000) and the cost of land (Cl = 10,000) are recovered, so that the annual expenditure of capital Atc in Year 10 is — 100,000 per year. Hence, the net annual cash flow (after tax) for Year 10 must reflect this recovery. By using Eq. (9-4),... 

Let us consider the net annual cash flows (after tax) Acf foi projects E, F, and G, hsted in Table 9-6. The cumulative annual cash flows X Acf 3.nd cumulative discounted annual cash flows X dcf, using a discount of 10 percent for these projec ts, are also hsted in Table 9-6. We notice that the cumulative annual cash flow for each project is -i- 1000. 

When to Scrap an Existing Process Let us suppose that a company invests 50,000 in a manufacturing process that has positive net annual flows (after tax) Acp of 10,000 in each year. During the third year of operation, an alternative process becomes available. The new process would require an investment of 40,000 but would have positive net annual cash flows (after tax) of 20,000 in each year. The cost of capital is 10 percent, and it is estimated that a market will exist for the product for at least 6 more years. Should the company continue with the existing process (project H), or should it scrap project H and adopt the new process (project 1) ... 

Two alternative projects are under consideration. Project A has a project life of 10 years and requires an initial investment of 100,000 with an annual cash flow after taxes of 20,000/year for each of 4 years followed by 10,000/year for years five... 

Year, n Net capital expenditure, Ajc Revenue from sales, s Total expenses. Ate Cash income, Aci (=As Ate) Depreciation charge. Ad Taxable income, Aci - Ad) Amount of tax at t= 0.5, Arr [= Aci - AD)t] Net cash flow after tax, Ace =Aci- Ajt Ajc) Discount factor at - 1 1 Discounted net cash flow, Adcf [= Acwifi)] Net present value (NPV),... 

The profit made by the plant is usually subject to taxation. Different tax codes apply in different countries and locations, and the taxable income may not be the full gross profit. Taxes are discussed in more detail in Section 6.5. The net profit (or cash flow after tax) is the amount left after taxes are paid ... 

Net annual income after taxes Net annual profit after taxes Net annual cash flow after taxes Value added (sales - raw materials cost)... 

In profitability assessments, annual cash flows are more meaningful than net profit. The net annual cash flow after taxes (CFxt) is the net profit after taxes less the annual expenditure of capital for additions and modifications. Net annual cash flows are used in discounted cash flow calculations to determine the NPV and the rate of return, which are two key measures used in economic decision analysis. 

Net annual cash flow after taxes = net annual income after taxes... 

NPV based on the net annual cash flow after taxes and minimum attractive rate of return ... 

The build up of annual cash flows and NPV and DCF is shown in Table B. Discounting the net cash flows after tax at the assumed cost of capital (10%) the project shows a NPV of — 3-86 million. At the lower discount rate of 5% a NPV of + 0 62 million is shown and by interpolation the DCF rate is 6%. Since the project shows a negative cash flow at the cost of capital it is unattractive. 

The cumulative net cash flow after tax is plotted against project life in Fig. A.2. This shows a payback time of almost 7 years from the start of the project. Measurement of the area under the curve to break-even shows just under 42 million years and with a maximum cumulative expenditure of 12 04 million the EMIP is almost 3-5 years. These values would have to be compared with target values set by known successes within the company. 

Discounting the net cash flow after tax at the cost of capital shows a negative NPV. The proposed project would therefore be unattractive and ways must be sought to reduce cost or increase sales income. 

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