Project Cash Flow Estimation
Financial Management
Project Cash Estimation
Significance of Cash Flows and Cash
Flow Estimation
The concept of “relevant” versus
“irrelevant” cash flows
Points to watch in estimating cash flows
How to estimate project operating cash
flows?
How to estimate project total cash flows?
Cash Flows
 To be consistent with wealth maximization
principle, an evaluation of a project must be
based on cash flows and not on accounting
profits
 To be able to use NPV technique or any other
technique of capital budgeting analysis
successfully and accurately, we must have
– an unbiased estimate of the expected future cash flows
of the project
– including time to completion and estimate initial
investment/cost
– extremely important and most difficult task
Projects have failed or succeeded due to
incorrect or correct estimates of the cash
flows of the project.
If cash flow estimates are incorrect, it
doesn’t matter which technique we use, the
project is doomed to fail
“Relevant” versus “Irrelevant”
Cash Flows
 The results of an acceptance of a project is to
change the cash flows of a firm.
 Cash flows of a firm that change because of the
project are called “relevant” cash flows;
 Any cash flows that does not change irrespective
of the acceptance/rejection of the project is
“irrelevant” to decision making and should not be
considered.
Points of Consider
Sunk Costs
Opportunity Costs
Project Externalities
Change in Net Working Capital
Sunk Costs
Sunk Costs—A cost that has already been
incurred and cannot be recovered
irrespective of the decision to accept or
reject the project.
R&D, Market Research, Consultant’s Fees
Is it relevant or irrelevant?
Opportunity Costs
 Opportunity Costs--The cash flow foregone by
using your resources in a particular way.
 Resources have multiple uses
 You can use them in one way to the exclusion of
other uses and this gives rise to opportunity costs
 By using your own building for your business,
you forego the rent that you could have earned by
renting it to some one else.
 Is it relevant or irrelevant to decision making?
Project Externalities
Project Externalities--the effect of a new
project (positive or negative) on an existing
project or division of a firm.
For instance, introduction of a new model
of a car on other existing models produced
by the same firm.
Is it relevant or irrelevant to decision
making?
Net Working Capital
Change in Net Working Capital--Net
working capital is defined as current assets
minus current liabilities.
Investment in working capital is a cash
outflow during the year in which
investment takes place
Any investment in working capital is a
cash inflow during the last year of the
project and must be treated accordingly
Estimating Project Cash Flows
Total Cash Flows of a Project in year t,
where t ranges from year 0 to year n.
= Project Operating Cash Flows for that
particular year – change in Net Working
Capital – initial investment
There is no project operating cash flows for
year 0
Estimating Project Operating
Cash Flows
Cash flows from operations for any year
– Estimated Sales Revenue *****
– Total Costs
*****
– Variable Costs
– Fixed Costs
per year
– Depreciation
***
***
***
 Sales Revenue minus Total Costs = Earnings Before Interest and Taxes
(EBIT)
– Deduct Taxes from EBIT
– Net Income
***
***
 Operating Cash Flows = Net Income +
Depreciation OR
 Operating Cash Flows= EBIT – Taxes +
Depreciation