Project Cash Flow Estimation

Financial Management

Project Cash Estimation

Significance of Cash Flows and Cash

Flow Estimation
The concept of relevant versus
irrelevant cash flows
Points to watch in estimating cash flows
How to estimate project operating cash
flows?
How to estimate project total cash flows?

Cash Flows
To be consistent with wealth maximization principle,

an evaluation of a project must be based on cash

flows and not on accounting profits
To be able to use NPV technique or any other
technique of capital budgeting analysis successfully
and accurately, we must have

an unbiased estimate of the expected future cash flows of

the project
including time to completion and estimate initial
investment/cost
extremely important and most difficult task

Projects have failed or succeeded due to

incorrect or correct estimates of the cash

flows of the project.
If cash flow estimates are incorrect, it
doesnt matter which technique we use, the
project is doomed to fail

Relevant versus Irrelevant

Cash Flows
The results of an acceptance of a project is to

change the cash flows of a firm.

Cash flows of a firm that change because of the
project are called relevant cash flows;
Any cash flows that does not change irrespective
of the acceptance/rejection of the project is
irrelevant to decision making and should not be
considered.

Points of Consider
Sunk Costs
Opportunity Costs
Project Externalities
Change in Net Working Capital

Sunk Costs
Sunk CostsA cost that has already been

incurred and cannot be recovered

irrespective of the decision to accept or
reject the project.
R&D, Market Research, Consultants Fees
Is it relevant or irrelevant?

Opportunity Costs
Opportunity Costs--The cash flow foregone by

using your resources in a particular way.

Resources have multiple uses
You can use them in one way to the exclusion of
other uses and this gives rise to opportunity costs
By using your own building for your business,
you forego the rent that you could have earned by
renting it to some one else.
Is it relevant or irrelevant to decision making?

Project Externalities
Project Externalities--the effect of a new

project (positive or negative) on an

existing project or division of a firm.
For instance, introduction of a new model
of a car on other existing models produced
by the same firm.
Is it relevant or irrelevant to decision
making?

Net Working Capital

Change in Net Working Capital--Net

working capital is defined as current assets

minus current liabilities.
Investment in working capital is a cash
outflow during the year in which
investment takes place
Any investment in working capital is a
cash inflow during the last year of the
project and must be treated accordingly

Estimating Project Cash Flows

Total Cash Flows of a Project in year t,

where t ranges from year 0 to year n.

= Project Operating Cash Flows for that
particular year change in Net Working
Capital initial investment

There is no project operating cash flows for

year 0

Estimating Project Operating

Cash Flows
Cash flows from operations for any year
Estimated Sales Revenue *****
Total Costs
*****
Variable Costs
Fixed Costs
per year
Depreciation

***
***
***

Sales Revenue minus Total Costs = Earnings Before Interest and Taxes

(EBIT)

Deduct Taxes from EBIT

Net Income
***

***

 Operating Cash Flows = Net Income +

Depreciation OR

Operating Cash Flows= EBIT Taxes +

Depreciation