Numerical Illustrations on Determining Cash Flows for Investment Analysis

Illustration 1: Initial Investment and Operating Cash Flows

Consider a manufacturing company evaluating the purchase of new equipment for

$200,000. The equipment is expected to generate annual cash inflows of $60,000 for the
next five years. Operating expenses are estimated at $20,000 per year, and the tax rate is
30%. Determine the initial investment and annual operating cash flows.

Solution:

1. Initial Investment: Initial Investment = Equipment Purchase Price Initial

Investment = $200,000
2. Annual Operating Cash Flows: Cash Inflows = Annual Revenue - Operating
Expenses Cash Inflows = $60,000 - $20,000 Cash Inflows = $40,000

Taxable Income = Cash Inflows - Depreciation Taxable Income = $40,000 -

(Equipment Cost / Useful Life) Taxable Income = $40,000 - ($200,000 / 5) Taxable
Income = $40,000 - $40,000 Taxable Income = $0

Taxes = Tax Rate * Taxable Income Taxes = 0.30 * $0 Taxes = $0

After-Tax Cash Flows = Cash Inflows - Taxes After-Tax Cash Flows = $40,000 - $0
After-Tax Cash Flows = $40,000

Annual Operating Cash Flows = After-Tax Cash Flows Annual Operating Cash
Flows = $40,000

Illustration 2: Terminal Cash Flow

Continuing from the previous illustration, suppose the salvage value of the equipment
at the end of five years is estimated to be $50,000. Determine the terminal cash flow.

Solution:

Terminal Cash Flow = Salvage Value Terminal Cash Flow = $50,000

Illustration 3: Financing Cash Flows

Consider the same investment scenario with the following financing details: the
company borrows $150,000 at an annual interest rate of 8% for the equipment
purchase. Determine the financing cash flows including interest payments and principal
repayment for the first year.

Solution:

1. Interest Expense: Interest Expense = Loan Amount * Interest Rate Interest

Expense = $150,000 * 0.08 Interest Expense = $12,000
2. Principal Repayment: Principal Repayment = Total Loan Repayment - Interest
Expense Principal Repayment = ($150,000 / 5) - $12,000 Principal Repayment =
$30,000 - $12,000 Principal Repayment = $18,000

Note: Assuming the loan is amortized over 5 years.

3. Financing Cash Flows: Cash Outflow (Initial Loan) = Equipment Purchase Price
Cash Outflow (Initial Loan) = $200,000

Cash Outflow (Principal Repayment) = Principal Repayment Cash Outflow

(Principal Repayment) = $18,000

Financing Cash Flows = Cash Outflow (Initial Loan) + Cash Outflow (Principal
Repayment) Financing Cash Flows = $200,000 + $18,000 Financing Cash Flows =
$218,000

Conclusion

These numerical illustrations demonstrate how to determine cash flows for investment
analysis, including initial investment, operating cash flows, terminal cash flow, and
financing cash flows. Understanding these components and conducting thorough cash
flow analysis is essential for evaluating investment opportunities and making informed
financial decisions.