Cash flow investment costs

Discounted Ca.sh Flows. Because the flows below the cash flow box in Figure 1 tend to be arbitrary management decisions that are generally difficult to predict, the prediction of profitabiUty is based on the expected cash flows instead of earnings. As a result, some logical assumptions to account for the cost of capital and the recovery of the investment must be made. 

Mfg cost (less depr and int) Capitalized fixed capital Capitalized total capital Operating income Interest on debt Depreciation (Tax basis) Net taxable income Federal income tax Investment tax credit Net income Cash flow... 

The cost of capital may also be considered as the interest rate at which money can be invested instead of putting it at risk in a manufacturing process. Let us consider the process data listed in Table 9-4 and plotted in Fig. 9-10. If the cost oi capital is 10 percent, then the appropriate discounted-cash-flow curve in Fig. 9-10 is abcdef. Up to point e, or 8.49 years, the capital is at risk. Point e is the discounted breakeven point (DEEP). At this point, the manufacturing process... 

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) ... 

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. 

Applying two important tax credits would improve the early years cash flow and shorten the payback period. A 10% investment tax credit and a 10% energy tax credit applied to the incremental capital costs for the expanders yields nearly 1.0 million additional first-year cash... 

Now that you have determined the likely savings in terms of annual process and waste-treatment operating costs associated with each option, consider the necessary investment required to implement each option. Investment can be assessed by looking at the payback period for each option that is, the time taken for a project to recover its financial outlay. A more detailed investment analysis may involve an assessment of the internal rate of return (IRR) and net present value (NPV) of the investment based on discounted cash flows. An analysis of investment risk allows you to rank the options identified. 

Finally, let s consider cash flow. Although cash flow does not have a direct effect on a company s revenues or expenses, the concept must be considered. If the project involves procurement costs, they often must be paid upon delivery of the equipment - yet cash recovery could take many months or even years. Three things about any project can affect a firm s available cash. First, cash is used at the time of purchase. Second, it takes time to realize financial returns from the project, through either enhanced revenues or decreased expenses. Depreciation expense is calculated at a much slower rate than the cash was spent. As a result of the investment, a company could find itself cash-poor. Even though cash flow does not directly affect revenues and expenses, it may be necessary to consider. 

Expenditure on corrosion prevention is an investment and appropriate accountancy techniques should be used to assess the true cost of any scheme. The main methods used to appraise investment projects are payback, annual rate of return and discounted cash flow (DCF). The last mentioned is the most appropriate technique since it is based on the principle that money has a time value. This means that a given sum of money available now is worth more than an equivalent sum at some future data, the difference in value depending on the rate of interest earned (discount rate) and the time interval. A full description of DCF is beyond the scope of this section, but this method of accounting can make a periodic maintenance scheme more attractive than if the time value of money were not considered. The concept is illustrated in general terms by considering a sum of money P invested at an... 

The chemical and petrochemical industries are highly capital intensive and this has two important implications for the plant designer. Before the expenditure for any plant is approved, a discounted cash flow (DCF) return on capital invested is projected (Section 9.1). The capital cost of the plant is a key factor in deciding whether the DCF return is above or below the cut-off value used by a company to judge the viability of projects. Thus, there is always strong pressure on the materials engineer not to overspecify the materials of construction. 

The net profit is the total income minus operating costs minus depreciation minus tax. The ROI is often calculated for the anticipated best year of the project the year in which the profit is greatest. This criterion is also used for small investments. In general, acceptable ROT are about 20 %, but typical values are difficult to give. Both POT and ROI provide a one-moment-in-time view and do not take into account future cash flows, which may not be constant in the lifetime of the venture. 

Net cash flow = sales income - costs - investment... 

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.

Payback time Payback time is the time that elapses from the start of the project (A in Figure 2.2) to the breakeven point (F in Figure 2.2). The shorter the payback time, the more attractive is the project. Payback time is often calculated as the time to recoup the capital investment based on the mean annual cash flow. In retrofit, payback time is usually calculated as the time to recoup the retrofit capital investment from the mean annual improvement in operating costs. 

A company has the option of investing in one of the two projects A or B. The capital cost of both projects is 1,000,000. The predicted annual cash flows for both projects are shown in Table 2.14. For each project, calculate the ... 

Chapter 3 treats the most common type of objective function, the cost or revenue function. Historically, the majority of optimization applications have involved trade-offs between capital costs and operating costs. The nature of the trade-off depends on a number of assumptions such as the desired rate of return on investment, service life, depreciation method, and so on. While an objective function based on net present value is preferred for the purposes of optimization, discounted cash flow based on spreadsheet analysis can be employed as well. 

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)... 

Payback period (PBP) the cost of an investment divided by the cash flow per period. 

For the accumulated costs and resources devoted to the development of a new chemical entity (NCE) or new molecular entity (NME) to make sense financially, the commercial potential of the compound must be evaluated in a rigorous manner. Compounds whose expected financial performance does not warrant these high investment costs must be abandoned or out-licensed as soon as possible so as to direct resources toward more profitable endeavors. By operating effectively, a well-designed drug discovery and development process can focus its efforts to operate efficiently on the compounds that will maximize cash flow to the pharmaceutical firm. 

Cash Payback is calculated by a cash flow analysis. The cash flow generated by an investment is the cash value of the benefits it achieves less the cash outlays to pay for the capital investment. Assuming that the system s costs precede its benefits, cash... 

The Net Present Value (NPV) of a capital investment is the equivalent total cash flow generated by all the acquisition s benefits less all the acquisition s costs computed over the life of the system on a year to year basis, adjusted for the value of money as reflected by such factors as finance rates, and projected ("discounted") to the present day. A dollar benefit projected for the system next year would only be worth 0.91 today if that dollar could be earning 10% interest. A net present value of zero means that the acquisition will, over its projected life, just break even and that it is therefore an acceptable purchase. A better than zero NPV would be a high priority purchase since it indicates a real profit. 

The principle of the NPV method is to forecast over time all cash flows associated with an investment. Each period s net cash flows are then discounted to the present.29 As discount rate usually the company s cost of capital is used because in this case a positive NPV indicates that the investment increases the company s value (cf. Rappaport 1998, p. 37 see Appendix 1 for a detailed discussion of how to derive the appropriate discount rate). The calculation of the NPV is based on the following formula ... 

In order to maximize the net present value of after-tax cash flows the model proposed in Chapter 3.4.2 has to be extended to determine the taxes payable in each country. To this end, pre-tax country profits comprising profits realized at both production and distribution entities have to be calculated. While the pre-tax profit of distribution entities can be calculated easily by subtracting all costs incurred from revenues realized, additional adjustments are required for production entities. Instead of cash flows associated with capital investments, depreciation costs have to be considered to identify pre-tax profits. The following assumptions are made to simplify the calculation ... 

The first finding for the commodity segment is that size does matter. Larger companies had less cyclical (though not higher) returns on invested capital, and the less cydical returns correlated, albeit mildly, with higher total returns to shareholders. These companies were not only able to cut their production costs, but also had suffidendy diversified offerings - and therefore sufficiently stable cash flows - to weather cycles for individual products. 

This chapter has been aimed at the revenue-earning project, the amounts of revenue leading to an annual cash flow, from which profitability, and hence economic feasibility, can be determined. But what if there are no revenues A new public service investment, such as a major (non-toll) road, or an overseas aid project, such as a water pipeline system for a sub-Saharan country, generate no revenues - yet may have huge investment costs. 

From this table a number of key discoveries can be made. Firstly, the total net cash flow of 156 millions is close to twice the total investment, so there is a reasonable overall profit. However, the undiscounted payback time is about 5 years and 8 months (the total revenues for years 1-5 are still 10 millions short of covering the total costs). This is a long time before payback - 2 to 3 years would be preferable - so this project is beginning to look a little unexciting. 

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