Capital Budgeting and Cash Flow Analysis
in Project Management
derek hendrikz
www.derekhendrikz.com
Copyright © 2014
Derek Hendrikz Consulting
www.derekhendrikz.com
www.derekhendrikz.com
www.derekhendrikz.com
the Cost Benefit principle….
 Obtain clarity about the objective to be attained.
 Identify alternative ways in which the objective may be
attained.
...
www.derekhendrikz.com
the Risk Return principle….
 This principle is a trade-off between risk and return.
 The greater the risk, the greater the required rate of
return.
...
www.derekhendrikz.com
the TimeValue of Money principle….
 This principle implies that the value of money
today does not equal the value of money
tomorrow.
 The basic assumption ...
 Capital budgeting places emphasis on cash
flows associated with projects, rather than
on accounting profit figures.
 An...
 This approach involves evaluating capital
expenditure proposals to determine
whether they are acceptable.
 If a project...
 This approach involves ranking projects on
the basis of some predetermined criterion,
such as the rate of return.
 The ...
 The payback period is the number of years
required to recover the initial investment.
 To calculate the payback period,...
 The payback period will be 2 years and six months (time to
recover initial investment).
 This is calculated by adding t...
 The NPV is calculated by subtracting the
initial investment from the present value of
the net cash inflows discounted at...
Year: Net Cash Flow: PVIF (12%): PV of Net Cash Flow:
1 R350 000 0.893 R312 550
2 R650 000 0.797 R518 050
3 R400 000 0.712...
Key In: Press: Calculator Display:
1 200 000 + Cfi -1200000.00
350 000 Cfi 350000.00
650 000 Cfi 650000.00
400 000 Cfi 400...
• After considering the ‘time value for
money’ at a 12% WACC, the return of
project will still exceed the initial
investme...
 Also called the benefit-cost ratio.
 The PI measures the present value return per
rand invested, while the NPV approach...
 The PI is R1,18.
 This implies that for each Rand invested, the
investor will receive R1,18 back.
 Since the return va...
 The IRR is probably the technique used most
often to evaluate investment alternatives.
 If the IRR is greater or equal ...
Key In: Press: Calculator Display:
1 200 000 + Cfi -1200000.00
350 000 Cfi 350000.00
650 000 Cfi 650000.00
400 000 Cfi 400...
• The WACC is 12%.
• The IRR is 20%.
• Project should therefore be accepted.
www.derekhendrikz.com
• Sales less - cost of goods sold
= gross profit
• Gross profit - operating expenses
= operating profit
• Operating profit...
Income Statement
Sales 1 450 000
Opening Inventory 240 000
Purchases 950 000
1 190 000
Closing Inventory 170 000
Cost of G...
Assets = Owners Equity + Liabilities
…
www.derekhendrikz.com
…
Assets: Owners’ Equity and Liabilities:
Fixed Assets 1000 Long term debt 300
Current Assets… 500 Current liabilities… 20...
Projected Cash Inflow – Projected Cash Outflow =
Projected Net Cash Flow
(Projected Net Cash Flow + Projected Beginning
Ca...
Projected Cash Inflow – Projected Cash Outflow = Projected Net Cash Flow
Projected Net Cash Flow + Projected Beginning Cas...
Capital Budgeting and Cash Flow Analysis for Project Managers by Derek Hendrikz
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Capital Budgeting and Cash Flow Analysis for Project Managers by Derek Hendrikz

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Capital budgeting and cash flow analysis by Derek Hendrikz for project managers works with financial risk management techniques to estimate project viability works with ratios, income-statements, risk return, time value for money, cost benefit, etc. www.derekhendrikz.com

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Capital Budgeting and Cash Flow Analysis for Project Managers by Derek Hendrikz

  1. 1. Capital Budgeting and Cash Flow Analysis in Project Management derek hendrikz www.derekhendrikz.com
  2. 2. Copyright © 2014 Derek Hendrikz Consulting www.derekhendrikz.com
  3. 3. www.derekhendrikz.com
  4. 4. www.derekhendrikz.com the Cost Benefit principle….
  5. 5.  Obtain clarity about the objective to be attained.  Identify alternative ways in which the objective may be attained.  Calculate the cost and benefits of each of the alternatives.  Determine the effectiveness of the benefits of each alternative.  Decide on a criterion or standard to be used against which the acceptability of an alternative may be weighed.  Take a decision about the most appropriate course of action. www.derekhendrikz.com
  6. 6. www.derekhendrikz.com the Risk Return principle….
  7. 7.  This principle is a trade-off between risk and return.  The greater the risk, the greater the required rate of return.  In other words, the return should exceed the risk involved in any business decision.  Risk is the probability that the actual result of a decision may deviate from the planned end result with an associated financial loss or waste in funds. www.derekhendrikz.com
  8. 8. www.derekhendrikz.com the TimeValue of Money principle….
  9. 9.  This principle implies that the value of money today does not equal the value of money tomorrow.  The basic assumption here is that a person could increase the value of an amount of money by investing it and earning interest on the amount. www.derekhendrikz.com
  10. 10.  Capital budgeting places emphasis on cash flows associated with projects, rather than on accounting profit figures.  An investment in projects can only add value if its return is greater than the required rate of return.  The return may be best measured in terms of the Net PresentValue (NPV) and the Internal Rate of Return (IRR). www.derekhendrikz.com
  11. 11.  This approach involves evaluating capital expenditure proposals to determine whether they are acceptable.  If a project does not meet the basic acceptance criterion, it should be eliminated from consideration. www.derekhendrikz.com
  12. 12.  This approach involves ranking projects on the basis of some predetermined criterion, such as the rate of return.  The project with the highest return is ranked first and the project with the lowest acceptable return, last. www.derekhendrikz.com
  13. 13.  The payback period is the number of years required to recover the initial investment.  To calculate the payback period, you need to establish when the initial investment will be covered. www.derekhendrikz.com
  14. 14.  The payback period will be 2 years and six months (time to recover initial investment).  This is calculated by adding the net cash flows of each year until the initial investment is covered (R350000 + R650000 + R400000 = (R1400000).  The initial investment is covered during the 3rd year, with R200000 left.Therefore we assume that the payback period is covered within the first six months of the year. www.derekhendrikz.com
  15. 15.  The NPV is calculated by subtracting the initial investment from the present value of the net cash inflows discounted at a rate equal to the firms cost of capital.  If a net present value exceeds zero, then the project can be acceptable, since initial investment (with consideration of time value for money) will be covered. www.derekhendrikz.com
  16. 16. Year: Net Cash Flow: PVIF (12%): PV of Net Cash Flow: 1 R350 000 0.893 R312 550 2 R650 000 0.797 R518 050 3 R400 000 0.712 R284 800 4 R300 000 0.636 R190 800 5 R201 000 0.567 R113 967 Total present value of cash flow: R1 420 167 Less initial investment R1 200 000 NPV R220 167 www.derekhendrikz.com
  17. 17. Key In: Press: Calculator Display: 1 200 000 + Cfi -1200000.00 350 000 Cfi 350000.00 650 000 Cfi 650000.00 400 000 Cfi 400000.00 300 000 Cfi 300000.00 201 025 Cfi 201025.00 12 i 12.00 NPV 220 110, 527 www.derekhendrikz.com
  18. 18. • After considering the ‘time value for money’ at a 12% WACC, the return of project will still exceed the initial investment. • The conclusion is therefore that the project should be accepted. www.derekhendrikz.com
  19. 19.  Also called the benefit-cost ratio.  The PI measures the present value return per rand invested, while the NPV approach gives the difference in rand between the present value of returns and the initial investment.  The PI is calculated as follows:  PI = Total present values of the present cash flows Initial investment www.derekhendrikz.com
  20. 20.  The PI is R1,18.  This implies that for each Rand invested, the investor will receive R1,18 back.  Since the return value is more than R1; the project should be accepted. www.derekhendrikz.com
  21. 21.  The IRR is probably the technique used most often to evaluate investment alternatives.  If the IRR is greater or equal to the cost of capital, accept the project, otherwise reject it. www.derekhendrikz.com
  22. 22. Key In: Press: Calculator Display: 1 200 000 + Cfi -1200000.00 350 000 Cfi 350000.00 650 000 Cfi 650000.00 400 000 Cfi 400000.00 300 000 Cfi 300000.00 201 025 Cfi 201025.00 12 i 12.00 NPV 220 110, 527 IRR 20 www.derekhendrikz.com
  23. 23. • The WACC is 12%. • The IRR is 20%. • Project should therefore be accepted. www.derekhendrikz.com
  24. 24. • Sales less - cost of goods sold = gross profit • Gross profit - operating expenses = operating profit • Operating profit - interest expenses = net profit before tax • Net profit before tax - tax = net profit after tax www.derekhendrikz.com
  25. 25. Income Statement Sales 1 450 000 Opening Inventory 240 000 Purchases 950 000 1 190 000 Closing Inventory 170 000 Cost of Goods Sold 1 020 000 Gross Profit 430 000 Other Expenses 210 000 180 000 Total Expenses 390 000 Net Profit 40 000 … www.derekhendrikz.com
  26. 26. Assets = Owners Equity + Liabilities … www.derekhendrikz.com
  27. 27. … Assets: Owners’ Equity and Liabilities: Fixed Assets 1000 Long term debt 300 Current Assets… 500 Current liabilities… 200 • Cash 200 • Accounts payable 100 • Inventory 100 • Short term loans 100 • Debtors 100 Owners Equity 1000 • Movable 100 Total: 1500 Total: 1500 www.derekhendrikz.com
  28. 28. Projected Cash Inflow – Projected Cash Outflow = Projected Net Cash Flow (Projected Net Cash Flow + Projected Beginning Cash Balance) – Projected Short Term Borrowing = Projected Ending Cash Balance (before borrowing) Projected Cash Inflow – Projected Cash Outflow = Projected Net Cash Flow Projected Net Cash Flow + Projected Beginning Cash Balance – Projected Short Term Borrowing = Projected Ending Cash Balance (before borrowing) www.derekhendrikz.com
  29. 29. Projected Cash Inflow – Projected Cash Outflow = Projected Net Cash Flow Projected Net Cash Flow + Projected Beginning Cash Balance – Projected Short Term Borrowing = Projected Ending Cash Balance (before borrowing) January February March April Projected Income Investment 5 000 Brought Forward 10 100 6 700 20 100 Income 10 000 15 000 16 000 9 000 Total Cash on Hand 15 000 25 100 22 700 29 100 Projected Expenses Equipment 300 300 1 800 0 Labour 3 000 3 200 300 300 Materials 1 600 0 500 1 000 Communication 0 900 0 1 200 Overheads 0 14 000 0 16 000 Total Expenses 4 900 18 400 2 600 18 500 Closing balance: 10 100 6 700 20 100 10 600 www.derekhendrikz.com

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