Analyzing Project Cash Flows - University of Nevada, Las Vegas

Analyzing Project Cash Flows

Chapter 12

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Principles Applied in This Chapter

Principle 3: Cash Flows Are the Source of Value. Principle 5: Individuals Respond to Incentives.

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Learning Objectives

1. Identify incremental cash flows that are relevant to project valuation.

2. Calculate and forecast project cash flows for expansiontype investments.

3. Evaluate the effect of inflation on project cash flows. 4. Calculate the incremental cash flows for replacement-

type investments.

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Project Cash Flows

Project cash flows for a capital investment typically fall into one of three categories of cash flows:

? The cash flows associated with the launching of the investment

? The operating period cash flows ? The terminal cash flows

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Project Cash Flows

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Identifying Incremental Cash Flows

Incremental cash flow refers to the additional cash flow a firm receives by taking on a new project.

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Guidelines for Forecasting Incremental Cash Flows

Sunk Costs (such as market research) and overhead costs (such as utilities expenses) are not incremental cash flows.

Account for positive and negative synergistic effects and opportunity costs.

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Guidelines for Forecasting Incremental Cash Flows

Work in Working Capital Requirement

Need for additional working capital arises as cash inflows and outflows are often mismatched.

Ignore Financing Costs

They are accounted for in the discount rate used to discount cash flows.

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