WELCOME

TO
LECTURE 9
SELESTIAN AUGUSTINO
 5.2.3.3 Cash flow
What is cash flow?
A cash flow means the net amount of cash and cash-equivalents
being transferred into and out of a business. 

Types of cash flow

1. Cash inflow (Cash in, revenue, income, assets, etc.)
2. Cash outflow (Cash out, liability, expenditure, etc.)

  
Differences between Cash inflow and cash outflow
Cash inflow
Cash are sale
 Receipts from trade debtors
 Sale of fixed assets
 Interest on bank balances
 Grants
 Loan from bank
Cash outflow
Cash are payee to suppliers
 Wages and salaries
 Payments for fixed assets
 Tax on profit
 Interest on loans and overdraft
 Dividends paid to shareholders
5.2.3.4 Elements of cash flow
What are the elements of cash flow?
The elements of cash flow are:
Operating activities
It reports the cash effects of the element of net income.

Investment activities
It reports the cash effects of the acquisition and disposition of
assets (other than inventory and cash equivalents) .
Financial activities
It reports the cash effects of the sale or repurchase of shares,
the issuance or repayment of debt securities, and the
payment of cash dividends.
  
Miscellaneous expenditure
Express the cash that incidental expenses which cannot be
classified as manufacturing, selling, and administrative
expenses
5.2.3.5 Time Value of Money
Briefly explain time value of money as used in financial
management
The Time Value of Money (TVM) refer to the concept that
money available at the present time worth more than the sum in
future due to its potential capacity. This core principle of finance
holds that provide money can earn interest any amount of money
is worth more than the sooner it is received.
5.2.3.6 Interest Rate of capital
What is interest rate of capital?
The interest rate is the amount a lender charges for the use of
assets expressed as a percentage of the principal. The interest
rate is typically noted on an annual basis known as the
annual percentage rate (APR). The assets borrowed could
include cash, consumer goods, or large assets such as a vehicle
or building.
5.2.3.7 Present value computation
Methods used are:
1. Net Present Value (NPV) method
2. Internal Rate of Return (IRR) method
Net Present Value (NPV) method
When the present value of all the future cash flows generated
from the project is added together (when they are positive or
negative) the result obtained is the Net Present Value (NPV).

NPV= Discounted cash inflows – Discounted cash outflows

Conditions for acceptance/rejection of a project

 Accept the project when NPV>0
 Reject the project when NPV<0
 May/may not accept the project when NPV=0
Formulas used;
 When cash flows are positive
NPV= C X (PVF)-i
Where
C is the cash flow expected to be received each period
PVF is the present value factor
i is the initial investment
When cash flows are negative
NPV = [C1/(1+k) + C2 /(1+k)^2 + C3 /(1+k)^3 + C4 /(1+k)^4+
C5/(1+k)^5] –Co
Where
C1, C2 , C3,…….., Cn are the net cash flows for the year 1, 2, 3, ..
……., n.
k is the opportunity cost of capital
n is the expected life of investment in years
Co is the initial investment
 Problem 1
Calculate the NPV of a project which requires an initial investment of
Tshs 243,000 and it is expected to generate a cash inflow of Tshs
50,000 each month for 12 months. Assume that the salvage value of
the project is zero. The target interest rate is 12% per annum.

Solution
Given
 Initial investment, Co = Tshs 243,000
 Net cash inflow per period, C = Tshs 50,000
 Number of periods, months = 12
 Discount rate per period, i = 12%
Required to calculate NPV
Formula:
NPV = C X (PVF)-i
= 50,000 X 11.255 - 243,000
= 562,750 - 243,000
= 319,750

Therefore the NPV is Tshs 319,750

 Problem 2
Assume that project X costs Tshs 25,000 now and is expected to
generate a cash inflows of Tshs 9000, Tshs 8000, Tshs 7000, Tshs 6000
and Tshs 5000 in years 1 through 5. The opportunity cost of the capital
may be assumed to be 10%. Calculate the NPV.

Solution
Given
 Initial investment, Co = Tshs 25,000
 Net cash inflows per period, C1 = Tshs 9000 , C2 = Tshs 8000,
C3 = Tshs 7000, C4 = Tshs 6000, C5 = Tshs 5000
 Discount rate per period, i = 10%
Required to calculate NPV
Formula:
NPV = [C1/(1+k) + C2 /(1+k)^2 + C3 /(1+k)^3 + C4 /(1+k)^4+
C5/(1+k)^5] –Co
= [9000/(1+0.1) + 8000 /(1+0.1)^2 + 7000 /(1+0.1)^3
+ 6000 /(1+0.1)^4+ 5000/(1+0.1)^5] –25,000
= [9000/(1.1) + 8000 /(1.1)^2 + 7000 /(1.1)^3
+ 6000 /(1.1)^4+ 5000/(1.1)^5] –25,000
= Tshs 2,255.28
Therefore the NPV is Tshs 2,255.28
Problem 3 (Class work )
Equipment A has cost of Tshs 75,000 and net cash flow of Tshs
20,000 per year for six years. A substitute equipment B would cost
Tshs 50,000 and generate net cash flow of Tshs 14,000 per year for
six years. The required rate of return of both equipments is 11%.
Calculate NPV and suggest which equipment should be accepted?
Answers
a. Equipment A ( NPV = Tshs 9,610)
b. Equipment B (NPV = Tshs 9,227)
c. Suggestion ( Equipment A will be accepted )
 Internal Rate of Return (IRR) method
This is the discounting cash flow technique which gives a rate of
return earned by the project.
Note down the following;
a) The rate of return of cash flow pattern is the interest rate at which the
present worth of that cash flow pattern reduces to zero.
b) In this method of comparison , the rate of return for each alternative
is computed .The alternative which has the highest rate of return is
selected as the best alternative.
 To find the net present worth at a given interest rate:
P w(i) = -P + A (P/A, i, n)
Where
P w(i) is the present worth at interest rate, i(%)
P is the principal or the amount at present
A is the amount at the end of the year/annual amount
i is the expected rate of return
n is the expected life of the project
Problem 4
Juma has planned a new project. The initial outlay and cash
flow pattern for the new project were listed below. The expected
life of the project is 5 years. Find the rate of return for the new
project.

Period (in years) 0 1 2 3 4 5

Cash Flows (in Tshs) -100,000 30,000 30,000 30,000 30,000 30,000
Solution
Given
P = 100,000 Tshs
A = 30,000 Tshs
N = 5 years
Required to find i(%) for Pw(i) = 0

Formula used:
Pw(i) = -P +A (P/A, i, n)
When i =10%
Pw (10%) = -100,000+ 30,000 (P/A,10%,5)
 = -100,000+30,000 (3.7908)
= 13,724 Tshs
:. Pw (10%) = 13,724 Tshs

When i =15%
Pw(15%) = -100,000 + 30,000 (P/A ,15%,5)
= -1,000,000 + 30,000(3.352)
= 566 Tshs
:. Pw(15%) = 566 Tshs
When i =18%
Pw(18%) = - 100,000+30,000(P/A,18%,5)
= - 100,000 +30,000(3.1272)
= - 6184 Tshs
:. Pw (18%) = - 6184 Tshs

Now, to find the rate of return, i

i = 15 %+ ((566-0)/(566-(-6,184)))* 3%
i = 15% + 0.252%
i = 15.252%
:. The rate of return for the new project is 15.252%.
Problem 5 (Part of your exercise only)
Mr. X has planned a new project. The initial outlay and cash flow pattern
for the new project were listed below. The expected life of the project is 5
years. Find the rate of return for the new project.
Period (in years) 0 1 2 3 4 5

Cash Flows (in Tshs) -1,000,000 300,000 300,000 300,000 300,000 300,000
 END OF LECTURE 9
THANK YOU
GOD BLESS YOU ALL
SELESTIAN AUGUSTINO