Cash flow example

Cost Advantage of Energy Efficient Homes Cash flow example for an average" home. 

To calculate the net present value (NPV) of an investment, a firm s accounting department estimates the firm s minimum desired rate of return. This is used to discount the cash flows above. For the cash flow example above, if we assume that the minimum desired rate of return for that firm is 10%, then the cash flow for each period is multiplied by the present value of a dollar for that period (i.e., P = S/(l -F r)° where S = 1, r is the interest rate or the desired rate of return, and n is the number of periods in the future) to find the present value of that cash flow. This is shown in Table 3.2. 

This gives two choices ia interpreting calculated NRR values, ie, a direct comparison of NRR values for different options or a comparison of the NRR value of each option with a previously defined NRR cutoff level for acceptabiUty. The NPV, DTC, and NRR can be iaterpreted as discounted measures of the return, iavestment, and return rate, analogous to the parameters of the earher example. These three parameters characterize a venture over its entire life. Additional parameters can be developed to characterize the cash flow pattern duting the early venture years. Eor example, the net payout time (NPT) is the number of operating years for the cumulative discounted cash flow to sum to zero. This characterizes the early cash flow pattern it can be viewed as a discounted measure of the expected operating time that the investment is at risk. 

Gash Flow Examples. Several hypothetical ventures are presented to illustrate cash flow analysis. Venture A exhibits a cash flow analysis. Venture A exhibits a cash flow pattern typical of process ventures. Other ventures are introduced for comparison and to provide additional insight into cash flow analysis. 

Example The present worth (PW) of a series of cash flows at the end of year k is... 

Example 3 Sensitivity Analysis The following data describe a project. Revenue from annual sales and total annual expense over a 10-year period are given in the first three columns of Table 9-5. The fixed-capital investment Cfc is 1 million. Plant items have a zero salvage value. Working capital C c is 90,000, and the cost of land Ci is 10,000. There are no tax allowances other than depreciation i.e., is zero. The fractional tax rate t is 0.50. For this project, the net present value for a 10 percent discount factor and straight-line depreciation was shown to be 276,210 and the discoiinted-cash-flow rate of return to be 16.4 percent per year. 

In effec t, in computing the average net annual cash flow per dollar invested, the value of f p of Eq. (9-46) has been obtained for this example. From tables of the annuity present-worth factor/ p the value of the interest rate is found to be = 0.25 when f p = 0.5124 with n = 3 years. 

Let us consider the effect of differential inflation on the overall profitability of the project of the last example. The effect of general inflation on this project showed that the apparent profitability rises sharply, to an (NPV) of 431,269 at a general inflation rate of 20 percent. However, when the cash flows of the (NPV) are properly corrected to their purchasing power in Year 0, the (NPV) instead becomes 208,733. 

The monitoring of cash flow is particularly important during conversion from conventional to organic farming. Certain systems may produce no returns for a year or more, suckler beef, for example, and under these circumstances it may be necessary to explore other... 

Figure 2.2 shows the cash flow pattern for a typical project. The cash flow is a cumulative cash flow. Consider Curve 1 in Figure 2.2. From the start of the project at Point A, cash is spent without any immediate return. The early stages of the project consist of development, design and other preliminary work, which causes the cumulative curve to dip to Point B. This is followed by the main phase of capital investment in buildings, plant and equipment, and the curve drops more steeply to Point C. Working capital is spent to commission the plant between Points C and D. Production starts at D, where revenue from sales begins. Initially, the rate of production is likely to be below design conditions until full production is achieved at E. At F, the cumulative cash flow is again zero. This is the project breakeven point. Toward the end of the projects life at G, the net rate of cash flow may decrease owing to, for example, increasing maintenance costs, a fall in the market price for the product, and so on.

R D. Returning to our examples, The R D lab, contributes to the long term profitability of the firm (rather than the short term cash flow) by developing and perfecting products and processes. While controlling the costs of R D as a whole is important, the speed at which a specific analytical test can be completed is less important than the speed and success at which a project as a whole can be completed. This relates to the effectiveness of the lab at its overall mission. The ability of a R D lab to quickly and successfully develop products and/or processes and if necessary to protect them through patent actions, may ultimately impact the firm s market share and its profitability. 

For an example of the kinds of decisions that involve the time value of money, examine the advertisement in Figure 3.1. For which option do you receive the most value Answers to this and similar questions sometimes may be quickly resolved using a calculator or computer without much thought. To understand the underlying assumptions and concepts behind file calculations, however, you need to account for cash flows in and out using the investment time line diagram for a project. Look at Figure 3.2. 

The basis for the calculations will be L = 100m. Because the insulation comes in 1-cm increments, let us calculate the net present value of insulating the pipe as a function of the independent variable jc vary x for a series of 1-, 2-, 3-cm (etc.) thick increments to get the respective internal rates of return, the payback period, and the return on investment. The latter two calculations are straightforward because of the assumption of five even values for the fuel saved. The net present value and internal rates of return can be compared for various thicknesses of insulation. The cost of the insulation is an initial negative cash flow, and a sum of five positive values represent the value of the heat saved. For example, for 1 cm insulation the net present value is (r = 0.291 from Table 3.1)... 

In Chapter 3 we discussed the formulation of objective functions without going into much detail about how the terms in an objective function are obtained in practice. The purpose of this appendix is to provide some brief information that can be used to obtain the coefficients in objective functions in economic optimization problems. Various methods and sources of information are outlined that help establish values for the revenues and costs involved in practical problems in design and operations. After we describe ways of estimating capital costs, operating costs, and revenues, we look at the matter of project evaluation and discuss the many contributions that make up the net income from a project, including interest, depreciation, and taxes. Cash flow is distinguished from income. Finally, some examples illustrate the application of the basic principles. 

A global value plan has to be calculated on the basis of the corporate base currency requiring all values measured in other currencies to be transformed into the basis currency applying exchange rate plans (Delf-mann/Alberts 2000) and also applying interest rates to discount period cash flows to a net present value of the tactical value plan (see also Eppen et al. 1989, p. 520 for an example in the automotive industry). 

The term f x D is only the result of an algebraic manipulation, and no interpretation should be assumed. This term f x D is the contribution to cash flow from depreciation, and (1 — t) x i and (1 — f) X C are the contributions to cash flow from revenues and cash operating expenses, respectively. Example 7 is a sample calculation of the after-tax cash flow and the tabulated results. 

Example 7 After-Tax Cash Flow The revenue from the manufacture of a product in the first year of operation is 9.0 million, and the cash operating expenses are 4.5 million. Depreciation on the invested capital is 1.7 million. If the federal income tax rate is 35 percent, calculate the after-tax cash flow. 

Net Present Worth Method The NPW method allows the conversion of all money flows to be discounted to the present time. Appropriate interest factors are applied depending on how and when the cash flow enters a venture. They may be instantaneous, as in the purchase of capital equipment, or uniform, as in operating expenses. The alternative with the more positive NPW is the one to be preferred. In some instances, the alternatives may have different lives so the cost analysis must be for the least common multiple number of years. For example, if alternative A has a 2-year life and alternative B has a 3-year hfe, then 6 years is the least common multiple. The rate of return, capitalized cost, cash flow, and uniform annual cost methods avoid this complication. 

Linking gas prices to that of other fuels (formula-based pricing) exposes cash flow to same kind of volatility as that of, for example, crude oil. Once downstream infrastructure is in place, it may become efficient to bring gas from other sources. Forex control may lock in upstream and midstream investment, reduce returns for investors and hinder debt servicing. 

Business valuation literature provides various other methods for estimating terminal values (for an overview see Koller et al. 2005, pp. 271-290). Unfortunately, as cash flows cannot be allocated to individual decisions in a network design model, a cash flow-based estimate is not possible. Instead, book value or liquidation value at the end of the planning horizon could be used. For example, Fong and Srinivasan (1981, p. 790) include a terminal value function in the unit capacity acquisition cost function. However, they do not specify how this function can be quantified in real-world applications. The major disadvantages are that it is difficult to justify the assumptions underling the terminal value estimate and that restructuring expenditures cannot be properly evaluated. 

Without any changes to the production network, the operating cash flows and the NPV of the network would be reduced by approximately 10% in comparison to the baseline values. However, by re-allocating production volumes within existing capacities, it is possible to restore previously earned operating cash flows. To do so, production volumes are shifted to the major site A, which is located in the Euro zone. Contrarily, site C, which is located in the USA, would not be utilized at all by the product groups included in the example. It should be noted that this does not imply a closure of the US site since only a subset of the product portfolio was included in the analysis. The net present value of the network is nevertheless affected by the US appreciation because of the restructuring costs associated with the re-allocation of production volumes. 

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