Project Cash Flows
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Correct calculation of cash flows is a must for evaluating capital budgeting decisions. It is the initial step in capital budgeting evaluation techniques.
Principles you should kept in mind while evaluating cash flows.
1. You must consider the cash flow in a long-term point of view.
2. Incremental cash flow is taken into consideration.
3. Financial costs are excluded from the calculations.
4. After tax cash flows must be estimated for the analysis.
Three categories on the basis of its time of occurrence.
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1. Initial Cash Outflow
Initial cash outflow includes all the funds invested by the firm or change in the cash flow of the firm at the beginning.
2. Interim Incremental Operating Cash Flows
The changes in cash flows throughout the life of asset are the interim cash flow.
3. Terminal Incremental Cash Flow
Terminal cash flow is the cash flows that occur at the end of the life of the asset.
Numerical Problem
XYZ Ltd. is considering the purchase of a new machine, which will cost $ 120000, plus an additional $ 7500 to ship and install. The new machine will have a 5 year useful life and will be depreciated to zero using a straight-line method. The machine is expected to generate new sales of $ 25000 per year and is expected to save $ 17000 in operating expenses each year over the next 5 years. The machine is expected to have a salvage value of $ 30000. Calculate initial, interim and terminal cash flows of XYZ. Firm’s income tax rate is 40%.
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