Project Cashflow Estimation

Aditya Jadhav
TAPMI
Incremental Cashflows

Cashflowt  Cashflowt withprojec t  Cashflowt withoutpro ject

Incidental Effects
• The changes in cash flows of other projects (and hence the firm) which are
not directly related to the project under evaluation but occurring due to
the acceptance of the concerned project are known as incidental cash
flows.
• Foregone earnings as opportunity costs for project cashflows
• Reduction in revenue or increase in costs of other projects to be
deducted from project cashflows
• Increase in variable labor or material expenses
• Increase in revenue or decrease in expenses of other projects to be
added to project cashflows
Indirect Expenses & Allocated Overheads
• General indirect expenses and allocated overheads to be ignored

• Additional fixed overhead expenses resulting due to acceptance of

the project should be appropriately considered for estimating the ICF
wherever required
Sunk Costs
• Costs relating to the project which have been already incurred in the
past or are already committed irrevocably are known as Sunk Costs.

• To be completely ignored
Financing Costs
• Financing costs (both interest and cost of equity) to be excluded from
estimation of project cashflows.

• Financing costs in the form of WACC are used as discounting rate to

estimate NPV and evaluate IRR
Tax Effect
  Market Value of Asset    
Less      
  Book Value of Asset  
      Depreciation of Asset Sold =
  Gain (loss)   Foregone Depreciation
 
Tax Effect to be considered in cash- Tax loss due to foregone
  flow = depreciation = Depreciation
Gain (loss) x Tax Rate Foregone x Tax rate
Cash-flow (Net)

Cash-flow from selling the asset at Market Value + Tax Gain (Loss)
Depreciation
• Depreciation is a non-tax expense

• Is initially deducted to arrive at taxable earnings

• Added back to post tax earnings to arrive at cash-flow

• Same treatment for all non-cash items

Salvage Value
Components of Salvage Value Effect
   
  Salvage Value
Less  
  Applicable Tax (Gain) on profit from sale of asset
   
The Applicable Tax (Gain) on Profit on Sale of Asset is calculated as
 
  Salvage Value
Less  
   Book
  Value
  Gain (Loss) from Sale
Thus  
  Gain (Loss) from Sale x Tax @ T%
=  
  Applicable Tax on Gain (Loss) from Sale
Working Capital
• Initial Working Capital requirement to be added to project costs to
arrive at Initial cashflow

• Additional working capital over the life of project to be added every

year in the operating cashflow

• The total working capital invested is recovered at the ned of project

life and captured in the terminal value
Value of the Project

  PV (Operating Cash Flows)

Add  
  PV (Terminal Cash Flows)
Less  
  Initial Cash Flows

  Net Present Value of the Project