CASHFLOW ESTIMATION

Cashflow Vs profit Incremental cash flow Components of cash flow

INTRODUCTION
 The most important, but the most difficult step

in capital budgeting is estimating projects cash flows.

 Evaluation techniques requires cash flows for

making investment decisions.

INTRODUCTION
 The difficulty in estimating cash flows arises

because of  Uncertainty and accounting ambiguities.  Requires considerable time, effort and money in obtaining correct estimates of cashflows  Requires the participation of many individuals and departments in the process

CASHFLOWS
 It is the inflow and outflow of cash.  It is the cash, which a firm can invest or pay

to creditors to discharge its obligations or distribute to shareholders as dividends.

 Cashflow should not be confused with profit.

CASHFLOWS VS. PROFIT

 Cashflow is different from profit at least for

two reasons  Profit, as measured by an accountant is based on accrual concept.  For computing profit, expenditures are arbitrarily divided into revenue and capital expenditure

CASHFLOWS VS. PROFIT

 Revenue expenditures are entirely charged to

profits while capital expenditures are not.  Only depreciation is charged to profit.
Profit = Revenue- expenses depreciation Cashflow = Revenue expenses- capital expenditure

INCREMENTAL CASHFLOWS
 A cashflow stream is a series of cash receipts

and payments over the life of an investment.  The estimates of amounts should be made on incremental basis.  Every investment involves a comparison of alternatives.

INCREMENTAL CASHFLOWS
 Suppose, a company is introducing a new

product, the incremental cash flows in this case will be determined by comparing cash flows resulting with or without introduction of the new project.  When incremental cash flows are calculated by comparing with a hypothetical zerocashflow project called absolute cash flows

INCREMENTAL CASHFLOWS
 When incremental cash flows are determined

by comparison between two real alternatives can be called relative cash flows  Incremental cash flows assume greater importance in case of replacement decisions.

PROBLEMS IN DETERMINATION OF INCREMENTAL CASH FLOWS

There are three main problems 1. Sunk cost A sunk cost is an outlay already occurred, hence not affected by the decision. 2. Opportunity cost for ex- Cash flows that could be generated from an asset the firm already owns.


PROBLEMS IN DETERMINATION OF INCREMENTAL CASH FLOWS

3. 

Effects on other parts of the firm / externalities Cannibalization

ELEMENTS/ COMPONENTS OF CASH FLOW

A typical investment will have three main components of cash flows 1. Initial investment 2. Annual net cashflows from operations 3. Terminal cash flows