Financial Analysis for

project feasibility
study… Continued
Projected cashflow
• Projected cash flow statement is used to evaluate cash inflows and
outflows to determine when, how much, and for how long cash
deficits or surpluses will exist for a business during an upcoming time
period.
• That information can then be used to justify loan requests, determine
repayment schedules, and plan for short-term investments.
• A projected cash flow statement is best defined as a listing of expected
cash inflows and outflows in the future operation.
• The word cash is crucial because only cash items are included in a
cash flow statement.
 Mikias Hotel Project -Projected cashflow

Project Period year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

[Link] Inflow

1.1 Financial resource total 313,310,467

1.2 Sales Revenue - 217,710,747 235,488,332 255,813,702 281,395,072 309,534,579 340,488,037 374,536,841 411,990,525 453,189,578 498,508,536

1.3 cash inflow total 217,710,747 235,488,332 255,813,702 281,395,072 309,534,579 340,488,037 374,536,841 411,990,525 453,189,578 498,508,536

[Link] outflow

2.1 Total Asset investment 313,310,467

2.2 operating costs 109,131,850 115,528,973 128,323,216 134,334,838 141,032,541 148,141,285 155,525,502 163,278,931 171,420,031 179,968,186

2.3 Debt sevice total 48,801,316 48,801,316 48,801,316 48,801,316 48,801,316 48,801,316 48,801,316 48,801,316 48,801,316 48,801,316

2.3.1 Interest - 39,477,119 37,798,763 35,818,304 33,481,362 30,723,770 27,469,811 23,630,140 19,099,329 13,752,971 7,444,269

2.3.2 Principal - 9,324,197 11,002,553 12,983,012 15,319,955 18,077,547 21,331,505 25,171,176 29,701,988 35,048,346 41,357,048

2.4 Devidend - 15,000,000 21,000,000 27,000,000

2.5 tax 8,601,696 12,519,341 15,372,817 21,944,824 29,204,643 37,334,245 46,485,522 56,754,842 68,276,135 81,199,987

Total cash outflow 215,336,179 225,650,947 241,298,666 253,882,295 267,839,817 283,078,162 299,613,657 317,636,406 337,298,799 358,770,805

[Link] /Deficit 2,374,568 9,837,385 14,515,036 27,512,777 41,694,762 57,409,875 74,923,184 94,354,119 115,890,779 139,737,730

cumulative cash flow - 2,374,568 12,211,953 26,726,989 54,239,766 95,934,529 153,344,404 228,267,588 322,621,707 438,512,486 578,250,216
Financial Analysis
Numeric Models
a) Ranking by Inspection
b) Return on investment (ROI)
c) Payback Period: the initial fixed investment in the project
divided by the estimated annual cash inflows from the project.
The ratio of these quantities is the number of years required for the
project to repay its initial fixed investment. For example, assume a
project costs $100,000 to implement and has annual net cash inflows
of $25,000. Then
Payback period = $100,000/$25,000= 4 years.
This method ignores any cash inflows beyond the payback period
d) Accounting Rate of Return (ARR)

4
 [Link] by Inspection (RI)
• Basic question: Given alternative investments which one
should be implemented and which one should be
discarded in a mutually exclusive investments?
• There may be an alternative as to build a hotel or a
factory on the same site.
• The investor might choose to start one with limited
resources he/she has.
• RI consists of choosing the best investment by comparing
the net proceeds of alternative investments.
• The project have more cash proceeds will be preferred
though are some peculiarities on inspections.

5
 Ranking by Inspection (RI) Steps……
• Comparing the net proceeds of A & B projects, we can
find out which project has shorter life period
• Compare the net proceeds of the short lived project with
long lived one
• If the two have the same initial investment & proceeds
throughout the period of the short lived investment; & if
the long lived investment continues to earn income after
the end of the short lived one, then the long lived one is
more desirable as the second project continues to earn
proceeds while the first one has ended

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Net Cash Flow of 4 Hypothetical Projects with Identical
Initial Investment Outlays & Life Periods

Project Initial Net Cash Proceeds in Years

Investment Cost

1 2 Total

A 20,000 20,000 - 20,000

B 20,000 20,000 2,000 22,000
C 20,000 14,625 9,825 24,450
D 20,000 16,325 8,125 24,000

Then, which one is more desirable-taking into account the net

proceeds?
7
 Project Selection Based on RI
• Although the total net proceeds of C & D are identical, D
earns more income earlier than C. Thus D is more desirable
than C
• Project B is more desirable than A

8
2. Return on Investment (ROI)

• Also called average income on cost

• Calculated by dividing the average income by the cost of
investment
Investment Cost ($) Average Average Ranking
income ($) income on cost
(%)
A 20,000 0 0 4
B 20,000 660 3.3 3
C 20,000 800 4 1
D 20,000 800 4 1
N.B: Project C & D are preferred than A or B, but B is preferred than
A.
Weakness of ROI: It doesn’t take into account the timing of the cash
flow.

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[Link]
Period
• The payback period is the length of time from the beginning of
the project until the sum of net incremental benefits of the
project equal to total capital investment.
• It is the amount of time it takes to recover the original/investment cost.
• The method is very simple.
• Moreover, it is a good measure when the project has problem of
liquidity.
• The pay-back period is also a common, rough means of choosing
among projects in business enterprise, especially when the choice
entails high degree of risk.
• Payback rule: If the calculated payback period is less than or equal to
some pre-specified payback period, then accept the project. Otherwise
reject it.

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This method has two important weaknesses:
First, it fails to consider the time & amount of net benefits
after the payback period.
Second, it does not adequately take into account the time
value of money even in the payable periods.
Payback Analysis
◦ how long will it take (usually, in years) to pay back the
project, and accrued costs:It indicates the number of years
the project will take to repay its investment cost
 It is the length of time between the starting time of the
project and the time when the initial investment is
recovered in the form of yearly benefits

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 Payback Period
Peak
cumulative
cash flow
Payback period
Total
+ve profit

Birr
Time

h
as
- ve

fc
w o
flo te
Ra
Cash trough Calculate annual net cash flow
Accumulate year on year
Cumulative net Plot on graph of CNCI against time
cash inflow
12
Payback Period
• If the expected cash inflow is a constant sum:

Pay Back period= Cash outlay (investment)

Net Annual cash inflows
If the expected cash inflow varies from period to period:

Pay Back period=Year before full recovery +

Unrecovered cost at the start of year
Cash flow during the year

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Payback Period
• But if the net cash inflow is the same across years, we use a
simple formula to get the payback period.
Example:
1. If Birr 2 million is invested to earn Birr 500,000 per annum
for 7 years, the pay back period is computed as follows:
• Pay back period = Br 2million/500,000= 4yrs

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Merits of payback period as an
investment appraisal technique

A. Simplicity
B. Rapidly changing technology, If new plant is likely to
be scrapped in a shorter period because of
obsolescence, a quick payback is essential,
C. Payback favors projects with a quick return
 Rapid project payback leads to rapid company
growth
 Rapid payback minimizes risk, Etc

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Critics of payback period as an
investment appraisal technique
• Project return may be ignored- in particular, cash flows
arising after the payback period are ignored.
• Timing is ignored
• Lack of objectivity-what length of time should be set as
the minimum payback period
• Project profitability is ignored-

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4) Accounting Rate of Return (ARR)
• The accounting rate of return (ARR), expresses the profit
forecast as a percentage of the capital expenditure involved
• ARR is a measure of profitability in accounting terms.
• This method aims to quantify the profits expected from
investment projects under consideration
• There are different methods of calculating the ARR

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Formulas For ARR
• ARR=Average Income after tax
Initial Investment
• ARR=Average Income after tax
Average Investment

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Time Value of Money
• Cash flow is an important concept in today’s business
language
• Cash inflow or outflow usually occurs over a period of time.
• This leads us to consider the time value of money
• The value of money depends on when the cash flow occurs
• Thus, the earlier value of money is greater than the latter
one
• Reasons: interest or rent, uncertainty, inflation

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Undiscounted Cash flow before
tax
Year 0 1 2 3 4 5
Cash flows -300 80 80 180 180 180

Cum cash -300 -220 -140 40 220 400

flow

NPV = 400 (in thousands)

PBP = 2.78 years

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Graphic Representation of Cash Flows

500

400

300

200

100
Cash flows
Cum cash flow
0
0 1 2 3 4 5

-100

-200

-300

-400

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Methods of estimating time value
of money
• Compounding and discounting
• Cash flows occur at different points of time
• For meaningful comparison, all these cash flows should be
assessed at the same point of time
• Either the cash flow occurring today has to be converted
into its equivalent at a future date or the cash occurring
later has to be converted back to today’s value
• The future value is calculated using compounding

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NPV: as Investment Criteria
NPV: it determines the net present value of all cash flows
by discounting them by the required rate of return.

n
Ct
NPV  A0   t
i 1 (1  r )

Where,
Ct = the net cash flow in period t

r = the required rate of return, and

A0 = initial cash investment (because this is an outflow, it will be
negative).

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Discounted cash flows for
interest 10%
Year 0 1 2 3 4 5
Cash flows -300 80 80 180 180 180

DF (10%) 1 0.909 0.826 0.751 0.683 0.621

Discounted -300 72.72 66.08 135.18 122.94 111.78
Cash flow
(DCF)
Cum DCF -300 -227.28 -161.2 -26.02 96.92 208.7

NPV = 208.7
DPBP= 3.2 years

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Graphical Representation of Cash
flows
500

400

300

200

100

0
1 2 3 4 5

-100

-200

-300 Cash flows NDCF Discounted Cash flow (DCF) Cum DCF

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NPV
Year Cash flow
0 Birr (1,000,000)
1 200,000
2 200,000
3 300,000
4 300,000
5 350,000

If the cost of capital (discount rate) is 10%, then NPV is calculated as follows

200,000 200,000 300,000

NPV  1
 2
 3

(1.10) (1.10) (1.10)
300,000 350,000
4
 5
 1,000,000  5,273
(1.10) (1.10)

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NPV
• The NPV represents the net benefit over and above the compensation
for time and risk.
• The decision rule associated with the net present value criterion is:
accept the project if the NPV is positive and reject it if NPV is negative.
• Properties of NPV:
• NPVs are additive:- The NPV of a package of projects is simply the sum
of the net present values of individual projects included in the package.
• NPV calculation permits time-varying discount rates:- when the
discount rate changes over time, we use a different formula like the one
shown below:

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NPV
Interest rate 14% 15% 16% 18% 20%
Investment 12000
Cash flow 4,000 5,000 7,000 6,000 5,000

PVC1 4,000 / 1.14 3509

PVC 2 5,000 /(1.14 1.15) 3814

PVC3 7,000 /(1.14 1.15 1.16) 4603

PVC4 6,000 /(1.14 1.15 1.16 1.18) 3344

PVC5 5,000 /(1.14 1.15 1.16 1.18 1.20) 2322

NPV of Project =3509+3814+4603+3344+2322-12000 = 5592

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• The Internal Rate of Return (IRR) is a financial metric used to evaluate
the profitability of an investment or project.
• It represents the discount rate at which the net present value (NPV) of
all cash flows (both inflows and outflows) from the investment equals
zero.
• In other words, it is the rate at which the present value of future cash
flows equals the initial investment cost.
f) IRR
 Internal Rate of Return (IRR);- emerges from the cost-benefit data of the
project
 It is the discount rate that reduces the NPV of a project to zero

IRR = Discount Rate, which makes the NPV zero

NPV

IRR

Discount Rate

30
 IRR

NPV
IRR Project-A

IRR Project-B

Discount rate

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IRR
• Internal rate of return (IRR)
• The internal rate of return is defined as the rate of discount, which brings
about equality between the present value of future net benefits & initial
investment. It is the value of r in the following equation.

n
Ct
I   1  r 
t 1
t

• I – investment cost
• Ct – Net benefit for year t
• r - IRR
• n - Life of the project
• Illustration: For project A in the above table can be formulated as follows:
IRR is PV(Benefits) = PV(Costs). Use algebra or a spreadsheet

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Criterion of IRR

• When using IRR, the investment criterion is that the IRR

should be greater than the discounted rate
IRR r/nship with other methods
 When the NPV (the discounted benefits are excess of the
discounted costs) is positive, then the IRR is greater than
the rate of discount
 When the NPV is 0, then the IRR is equal to the rate of
discount and the discounted benefits are equal to the
discounted costs
 When the NPV is negative, then the IRR is smaller than the
discount rate and the discounted benefits are smaller than
the discounted costs

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Conditions of Financial Viability of a Project

• The acceptance criterion for an investment is:

NPV positive,
IRR greater than the discounted rate; and
 discounted benefits greater than discounted costs

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 f. Benefit-Cost Ratio (BCR) Computation

• BCR =

Or

Pr esent Value of Cash Inflows

BCR 
Pr esent Value of Cash Outflows

35
End of Class

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