Economics

Section (8)

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 Agenda

ü Cash flow

ü Sheet problems

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Cash flow
Cash flow refers to the movement of money in
and out of a business, project, or financial
product over a specific period. It's a crucial
metric for understanding a company's financial
health and operational efficiency.

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Cash flow
Net Present Value (NPV) or NPW
• It is the total present value (PV) of a time
series of cash flows. It is a standard method
for using the time value of money to appraise
long-term projects.

• We can use the NPV or NPW to judge on

projects

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Cash flow
Net Future Worth (NFW)
• It is the total future value (FV) of a time series
of cash flows. It is a standard method for using
the time value of money to appraise long-
term projects.

• We can use the NFW to judge on project.

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Cash flow
Important Definitions:
NPV Net Present value

NSW Net Future value

CFn Cash flow in period n

i Discount rate

N Number of periods

TRR True rate of return and it is just another name for the DCFRR

DCFRR Discounted Cash Flow Rate of Return (Value of rate of return i at NPW = 0 and NFW = 0)

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 What if the NPV is

Cash flow
slightly above zero,
would this be
accepted??

if Meaning Therfore

NPV>0 the investment would add value to The project may be accepted
the firm

NPV<0 the investment would subtract value The project should be rejected
from the firm

NPV=0 the investment would neither gain We should be indifferent in the

nor lose value for the firm
decision whether to accept or reject
the project. This project adds no
monetary value. Decision should be
based on other criteria, e.g. strategic
positioning or other factors not
explicitly included in the calculation.

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Cash flow

NPV = ΣCFn / (1 + i)n , n = 1..N

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Cash flow
Sheet - Problem 1:
A corporation must decide whether to introduce a new product line. The new product will have
startup costs, operational costs, and incoming cash flows over nine years. This project will have
an immediate (t=0) cash outflow of $100,000 (which might include machinery, and employee
training costs). Other cash outflows for years 1-9 are expected to be $5,000 per year. Cash inflows
are expected to be $30,000 each for years 1-9. All cash flows are after-tax, and there are no cash
flows expected after year 9. The interest rate is 10%, calculate the NPV and mention whether to
do the project or not, also draw a cash flow diagram.

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Cash flow net inflow
each year is
$25,000

Sheet - Problem 1:
• The following table shows the NPV of each cash
flow and the NPV of the whole project is the
summation of all the NPV of all the cash flows.

• The total present value of future cash flows, or

Net Present Value (NPV), is $44,000.

• Since this is positive, investing in the project is

preferable to inaction. It's a good option unless a
better investment (higher NPV) exists.

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Cash flow

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Cash flow
Sheet - Problem 2:
Suppose that $150,000 were invested for research and development in a certain firm 1 year ago
and research is now completed, because of this research, annual savings of $65,000 or the next 4
years will occur, would the project be justified at I = 10%?

Also find the value of i (rate on return) that makes the project justified if the investment was
made 2 years ago instead of 1 year ago.

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Cash flow
Sheet - Problem 2: NPV > 0, Project is
justified for
I = 10%

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Cash flow
Sheet - Problem 2:

Equate the NPV with zero and by trial and error

get the value of i, it will be the value which
makes the project just justified as it neither lose
nor make profit.

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Cash flow
Sheet - Problem 3:
A proposed project has the following data:

Initial fixed investment of $200,000, WCI of $20,000 and final salvage value of $20,000 and
the series of cash flow are:

Determine TRR ??

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Cash flow Remember:
TRR = DCFRR and
equal to the value of
rate of return i at NPW
= 0 and NFW = 0
Sheet - Problem 3:

• Both the WCI & the salvage value are returned at the
end of the project, so both values are added here on
the cash of year 7
• Any value between brackets means it is a negative
value or out cash flow
• Equate the NPW with zero and get value of I, either
by trial and error or using calculator.

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Cash flow
Sheet - Problem 4:
Consider the following project, working at rate of return (I) = 15%, evaluate
the Project using the TRR technique.

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 NFW may be easier in

Cash flow this problem.

Try as we have done
in the section !

Sheet - Problem 4:
• If the project’s IRR is higher than the DCFRR, the project generates

a loss.

• Conversely, if the IRR is lower than the DCFRR, the project results in
a profit.

Project Evaluation:

• We can calculate the DCFRR, but solving for it directly can be

challenging.

• Instead, we can compare the given required rate of return

(RRR) with the calculated DCFRR.

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Cash flow
Sheet - Problem 4:
In this example:

• The DCFRR is 17.4%.

• Since the required rate of return (presumably IRR) is 15%, which is lower than the

DCFRR, the project is considered financially viable.

• In this problem we used the annuity rule in order to calculate NPW of the cash flows
from year 6 to 15, this rule is as follows:
P = R ((1 + i)n – 1)/ i (1 + i)n )
where P is present worth , R is the repeated cash flow. N is the number of years.
• In our problem n = 10 , = (15- 6 + 1) because year 6 is included, then we multiplied by
1/(1 + i )^5, because the annuity rule gets the P value at the beginning of year 6 which
is nearly at the end of year 5 so we just want to get this value back 5 years not 6!

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 Thank You

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