Evaluating Cash Flows
The first step in this analysis is to compute the cash flows and discounted cash flows with the previous years' cash flows up to and substitute the current year and will show the amount of money is still invested or associated in the project at this time. Suitable signals brought forth by the project. Based on them we can compute the following:
1) Discounted cash flows percentage in the primary investment.
by and large the investment or the initial cost occurs in the first year(s) of the project and is registered as a negative cash flow. If the investment is spread over several years, the initial investment is believed to be the sum of all these yearly expenditures, or more correctly the sum of all discounted expenditures, which is the present value (PV) in the first year of all investments to be made for the project.
The percentage of each cash flow in the initial investment tells us how much we invest or how much we recover from our total amount investment every year during the economic life span of the project.
If the initial investment is believed in absolute value, therefore a positive number, and each cash flow is believed with the suitable sign, then the percentage of discounted cash flows will be negative for the years when the project calls for investments and positive for the years when the project brings forth revenues.
2) The accumulated percentage of the discounted cash flows in the initial investment.
For each year, it is merely the sum of the percentages previously computed for all the years before and substitute the year believed. It approximately demonstrates how deep we are into debt. An accumulated percentage of -100% will be incurred for the year when the investment is completed. This is when the debt is the 'deepest'. After this year we will start recovering some part of the investment every year and the accumulated percentage will demonstrate how much there is still to be retrieved from the investment. The accumulated percentage for the previous year will equal the percentage of the present value (PV) of the project i.e. the sum of all discounted cash flows in the initial investment or expenditures.
3) Cash balances are the sum of all cash flows already realized at any provided point of time. For each year the cash balance will equal the sum of all Cash balances are At the beginning negative for most projects, as they start with expenditures and investments. It is significant to note the maximum negative cash balance in absolute value and when it occurs. This number will demonstrate the maximum investment that, at some point in time, is linked in the project. Even if the project is overall profitable, if one cannot secure this maximum negative cash balance at the specific time when it occurs, one cannot attempt the project.
As the project starts bringing forth revenues, cash flows become positive, therefore the negative cash balances decrease in magnitude, but are still negative for a while as long as revenues brought forth by the project do not exceed the investment. The decrease in the absolute value of cash balances merely demonstrates that the investor commences to recover part of the investment attained.
A second thing significant to note is when we obtain the first positive cash balance. This moment is called payback period and represents the period of time required to retrieve all the initial investment and receive the first dollar of profit.
The aggregate of all cash balances at the end of the project will equal the sum of all discounted cash flows. An issue raised by cash balances is that they do not take into account the interest that must be paid for any amount took over from the bank or the interest brought in, on any amount saved in the bank. In reality, the negative cash balances carried forward from one year to some other in the first year of the project are equivalent to a debt, on which interest should be paid. Once cash balances tum positive, they are equivalent to some money saved in the bank and interest is brought in for all subsequent years. Therefore, a better criterion of the amount of money associated in the project is provided by the interest established cash balances.
4) The interest based cash balance (IBCB)
The interest established cash balance for the current period is obtained by adding the current cash flow to the interest established cash balance carried from the previous period and the interest that applies to it. Similar to cash balances, interest established cash balance for the project are negative for the first years due to investments or outflows and become positive as the project brings forth adequate revenues to recover the costs. For most of the projects the maximum negative interest based cash balance , which demonstrates the maximum amount invested in a project at any provided point in time when interest is believed, is larger than the maximum negative cash balance. This is merely since for any amount invested, like for any debt, interest should be paid.
The interest established payback period or discounted payback period is the moment when the project's inflows exceed the project outflows, interest being believed, or the moment when we obtain the first positive interest based cash balance . It is by and large greater than the payback period. The ground for this is that we require time to recover not only the initial expenditures or investments, but also the interest that implements to them. The last interest established cash balance obtained for the project will equal the future value of the project in the final year, with the desirable interest rate compounded, the cumulative sum of all cash flows .
5) The profitability index- PI (the cost-benefit ratio)
This ratio computes the present value (PV) of all inflows to the present value (PV) of all outflows. A project is profitable when its net present value is positive, therefore the present value (PV) of benefits is higher than the present value (PV) of costs. It must be then that the project should be attempted when the profitability index is larger than 1, and it is not profitable when the index is less than 1.
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