7/30/2019 Fm 3 notes by narain
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Narain
Cost Benefit measurement
Profit is not a theoretical superior basis ofmeasurement
Cash Flow is considered to be the superiorbasis of measurement
Is not affected by the Accounting conventions
Objective and verifiable
Cash Flow models can also be taken atdifferent levels of analysis
Operating Free Cash Flow
Free Cash Flow to Equity
7/30/2019 Fm 3 notes by narain
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Narain
Cash Flows of the Project
Aftertax incremental operating cash flows
Only the cash flows which are incremental in natureand directly attributable to the project are relevant
Net of tax effect
tax liability or tax shield
Depreciation & Amortisation non cash items butaffects taxes
Indirect overheads ignore if not affected by the
project
Effect on other projects consider with the projectsflows
Opportunity costs consider with the project flows
7/30/2019 Fm 3 notes by narain
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Narain
Cash Flows of the Project
Financial charges ignore in the project flows
Investment & Financing decisions are
considered separately
Avoids double counting as these charges are
reflected in the hurdle rate
Changes in working capital consider with
the project flows Only changes are considered
Need arise because account books are kept on
accrual basis
7/30/2019 Fm 3 notes by narain
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Narain
Proforma Cash Flow Statement
1. Cash flow from operations
Profit before tax
+ Depreciation & other non-cash items
+ Interest & other non-operating items- Income tax paid
- Increase in Working Capital
2. Cash flow from investing
Cash paid to acquire Fixed AssetCash received for disposing Fixed Asset
3. Cash flow from financing
Interest/Dividend paid
Capital funds raised
7/30/2019 Fm 3 notes by narain
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Narain
Cash flow computation
With the help of following projected Income Statement,calculate the cash inflow:
Net Sales Revenue 475000
Cost of goods sold 200000
General expenses 100000
Depreciation 50000 350000
Profit before interest and taxes 125000
Interest 25000
Profit before tax 100000
Tax @30% 30000
Profit after tax 70000
7/30/2019 Fm 3 notes by narain
6/14
Narain
Cash flow computations
The cost of a new plant is Rs. 5,00,000. Ithas an estimated life of 5 years after
which it would be disposed off (scrapvalue is nil). Profit before depreciation,interest and taxes (PBIT) is estimated tobe Rs. 1,75,000 p.a.
Find out the yearly cash flow from the plant,if tax rate is assumed to be 30% anddepreciation is provided on straight line
basis.
7/30/2019 Fm 3 notes by narain
7/14
Narain
Cash flow computations
ABC Ltd. is evaluating a capital budgetingproposal for which relevant figures are asfollows:
Compute cash flows for the relevant periodassuming written down method of providing
depreciation.
Cost of Plant Rs. 11,00,000Installation cost Rs. 3,400
Economic life 7 years
Scrap value Rs. 30,000
Profit before depreciation and tax Rs. 5,00,000Tax rate 30%
7/30/2019 Fm 3 notes by narain
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Narain
Illustration 1
A company will create a computer facility at thecost of Rs. 2 lac. The annual maintenancecost shall be Rs. 20,000. After 5 years the
system will be phased out. The expectedscrap value is Rs. 40,000. The project grosscash inflows are expected to be:
Compute the cash flows for the project if taxrate is 30% and depreciation is provided at
60% WDV.
1st yr 2nd yr 3rd yr 4th yr 5th yr
50,000 80,000 1,00,000 80,000 60,000
7/30/2019 Fm 3 notes by narain
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Narain
Illustration 2
A firm is using a two year old machine that waspurchased for Rs. 70,000. The remaining life is 5years. Depreciation rate is 40%.
Firm is considering its replacement with a newmachine costing Rs. 1,40,000 which would be used for5 years. The installation charges will be Rs. 10,000.The increase in the working capital requirement will beRs. 20,000 as a result of using the new machine. The
firm is subject to income tax rate of 35% and capitalgains tax rate of 30%.
Determine the initial cash flow if salvage value of existingmachine is (a) 80,000 (b) 60,000 (c) 50,000 (d)20,000.
7/30/2019 Fm 3 notes by narain
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Narain
Illustration 3
A machine has a book value of Rs. 90,000. andremaining life of 5 years. It is depreciable @20%. Its present salvage value is its book
value but nil after 5 years.
It can be replaced with a new machine worthRs. 4,00,000. It will have a salvage value of
Rs. 2,50,000 after 5 years. The new machinewill save Rs. 1,00,000 p.a. in manufacturingcosts. It will depreciate @ 33.33%. The taxrate is 35%.
Determine the post tax incremental cash flow.
7/30/2019 Fm 3 notes by narain
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Narain
Exercise
A machine purchased for Rs. 96,000 has a bookvalue of Rs. 24,000 and remaining life of 4years. It is depreciable @ 50%. Its present
salvage value is Rs. 20,000 but nil after 4years.
It can be replaced with a new machine worth
Rs. 1,30,000. It will have a salvage value ofRs. 8,000 after 4 years. The new machine willsave Rs. 60,000 in manufacturing costs. Itwill depreciate @ 40%. The tax rate is 35%.
Determine the post tax incremental cash flow.
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IllustrationFind incremental CFAT from the following information:
Purchase price of the new asset 10,00,000Installation costs 2,00,000
Increase in working capital in year zero 2,50,000
Scrap value of the new asset after 4 years 3,50,000
Annual revenues from new asset 21,50,000
Annual cash expenses on new asset 9,50,000
Current book value of old asset 4,00,000
Present scrap value of old asset 5,00,000
Annual revenue from old asset 19,25,000
Annual cash expenses on old asset 11,25,000
Planning period 4 years
Depreciation on new asset 20%
Depreciation on old asset 25%
Tax rate 30%
7/30/2019 Fm 3 notes by narain
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Exercise
A company is considering to install a machine costing Rs.5,00,000 with an additional investment of Rs. 1,50,000 forits installation. The salvage value at the end of year 10 is
estimated at Rs. 2,50,000. The machine is estimated togenerate a sales revenue of Rs. 20,00,000 in the first yearand the sales are expected to grow at 5% p.a. for theremaining life of the machine. The profit after tax isexpected at 10% of the sales while the working capitalrequirement are expected to be 5% of the sales.
Compute the cash flows assuming SLM depreciation andadditional working capital is required at the beginning ofeach year and is fully salvageable.
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Narain
Solution
Initial investment outlay Rs. 7,50,000
First Year CFAT Rs. 2,35,000
Second Year CFAT Rs. 2,44,750
Third Year CFAT
Rs. 2,54,987
Fourth Year CFAT Rs. 2,65,737
Fifth Year CFAT Rs. 2,77,024
Sixth Year CFAT Rs. 2,88,875
Seventh Year CFAT Rs. 3,01,319
Eighth Year CFAT Rs. 3,14,385
Ninth Year CFAT Rs. 3,28,104
Tenth Year CFAT
Rs. 7,55,396
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