PROJECT FORMULATION & APPRAISAL

CHAPTER 3
ANALYSIS OF PROJECT CASHFLOW

Phùng Tuấn Thành

Mobile phone: 0989.617.888
Email: [email protected]

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MAIN CONTENT

vThe basic concepts

vPrepare project cash flows
vProject cashflow perspectives

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 BASIC CONCEPT
v Time value of money
• Definition: is the concept that sums of money at different times have different
values. Often, we see money available now to be worth more than the same
amount in the future due to its potential profitability.
• Reason:
- Opportunity to use money
- Inflation always present
- Risk not getting that money in future
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 BASIC CONCEPT
• The value of a sum of money
§ Future value: Converting the current value of money to a certain time in the future (also
known as cumulative action)
- Simple Interest: Interest is calculated on the basis of the principal, not on the amount of
interest accrued over each period.
FV = PV x (1+ n x r)
- Compound interest: Interest is calculated on the outstanding balance at the beginning of the
period, interest in previous periods is added to the principal to calculate interest for the
following periods.
FV = PV (1 + i)n

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 BASIC CONCEPT

o The power of accumulation:

- Suppose, in 1626, the Native American residents of Manhattan Island
invested the $24 they received from the sale of the Manhattan
peninsula at an 8% annual interest rate.
- This is what they will have in 2023
Simple interest Annual compound interest
24 x (1 + 398 x 0,08) = 24 x (1 + 0,08)398 = 481,799
788,16 USD thousands of billions USD
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 BASIC CONCEPT
§ Present Value: Converts the value of money at future times to a present time (also known as a discounting
action)
- Simple interest: PV = FV / {1 + n x r}

- Compounding: PV = FV / (1 + i)n
§ Interest statements:
- Nominal statement: interest rates have a different compounding period than the disclosure period.

for example: Interest rate 10%/year, compounding interest every 6 months (0.5 years)/time
- True statement: interest rate whose compounding period is the same as the disclosure period.

for example: Interest rate 10%/year, compounding 12 months (1 year)/time

- Relationship between real and nominal statements

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 BASIC CONCEPT
• Value of a Money Chain:
§ Future value:
o Cash flow at the end of the period
- Mixed cash flow

- For example: At the end of year 1 deposit 100 million VND in the bank, at the end of
year 2 deposit in the bank 200 million VND, at the end of the 3rd year deposit in the
bank 150 million VND, at the end of the 4th year deposit 300 million VND in the bank.
How much is the total amount in the bank account at the end of the 4th year, knowing
that the bank interest rate is 6%/year?
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 BASIC CONCEPT

- - Regular cash flow:

- For example: At the end of each year, Hung Thinh company deposits
100 million VND in the bank, the bank interest rate is 8%/year. How
much money will the company receive after 7 years?

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 BASIC CONCEPT

o Cash flow at the begining of the period

- Mixed cash flow

- For example: Invest in a project with the following capital, at the beginning of year
1 is 300 million VND, at the beginning of year 2 is 200 million VND, at the
beginning of year 3 is 400 million VND, at the beginning of year 4 is 100 million
VND, ask later at the end of the investment project (end of year 4), how much is the
proceeds, knowing that the investment interest rate is 10%/year.

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 BASIC CONCEPT

- - Regular cash flow:

- For example: At the beginning of each month, deposit 2 million VND

in the bank, the interest rate is 16%/year, in 1 year and 8 months
calculate the total amount received.
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 BASIC CONCEPT

§ Present value:
‣Mixed cash flows at the end of the period

‣Cash flows are generated at the end of the

period

‣Mixed cash flows at the beginning of the period

‣Cash flows are generated at the beginning

‣of the period
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BASIC CONCEPT

‣Permanent cash flow arises at the beginning of

the period

‣Cash flow is eternal

has a fixed growth rate arising at the beginning of the period

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BASIC CONCEPT

- For example: The income from the project is given as follows: At the end of

year 1 is 2 billion VND, at the end of year 2 is 3 billion VND, at the end of year
3 is 4 billion VND, Investment interest rate is 15%/year, asking total capital
How much is the initial investment?
- For example: The first payment to the bank every month is 5 million VND,
knowing the bank interest rate is 8%/year, paying in 1 year and 3 months, the
debt will be cleared, ask how much the initial loan is.

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 BASIC CONCEPT

• Calculation of monthly savings for retirement: Let's say you started

working at the age of 25, at the end of each month you have to put
aside how much money to deposit in the bank, so that when you are 65
years old (starting to retire), you begin to gradually withdraw every
month to spend. until the end of life (estimated 85 years).

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 BASIC CONCEPT
v Opportunity cost
- The opportunity cost of using a resource in a project is the greatest alternative benefit that could
be obtained if the resource were given to another project.
- In financial analysis, opportunity cost is not an actual expenditure, but should still be counted as
a cash outflow of the project.
v Sunk costs
- Sunk costs are defined as costs that have been paid since the time of financial analysis
(historical costs) and are not included in investment costs when evaluating project investment
efficiency.
- The decision to implement the project does not depend on sunk costs

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 BASIC CONCEPT

v Depreciation:
• Define:
- It is a tool in terms of accounting and planning to allocate fixed
investment costs to product costs every year
- As a factor of production cost à Depreciation reduces income tax
- Depreciation is not a cash expense, just a form of journaling à No
direct impact on cash flow (only indirectly through taxes and
liquidation value of fixed assets)
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 BASIC CONCEPT

• Depreciation methods
§ Straight Line Depreciation
- The simplest and traditional depreciation
- Depreciation is depreciated equally every year throughout the amortization
period
SLD = {First value – Residual value} / Asset life

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 BASIC CONCEPT

§ Sum of the Years' digits Depreciation

- Also known as accelerated depreciation
- Take the total of the years and add up to a total

- Depreciation rate is n/sum (with reverse order)

SYD = {n/sum} x {First value – Residual value}

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 BASIC CONCEPT
§ Declining Balance Depreciation
- Apply to areas of technology that require rapid change
DBD = Residual value x Fast depreciation rate

Fast depreciation rate = Straight rate of depreciation x Adjustment

factor
- When the DBD depreciation is less than the average depreciation à Convert
the annual depreciation rate to the residual value divided by the number of
years of remaining use
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BASIC CONCEPT

❖Debt repayment plan: need to consider loan needs, approach, loan

term, disbursement plan, and repayment term.
• Loan interest rate: Fixed and adjustable.
• Payment method: Constant amortization mortgage (CAM) and
Constant payment mortgage (CPM)

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 PROJECT CASHFLOW SETTING
v Net cash flow:
• Concept:
- Net cash flow (also known as free cash flow) is the final cash flow that belongs only to those with an
interest in the project as owners and creditors.
- In other words, the net cash flows of the project are equal to the cash flows of the owners and the cash
flows of the creditors
• Cashflow and Profit:
- Profit reflects project performance but does not reflect non-cash income and expenses, so it is not
accurate.
- Cash flows reflect all cash inflows and outflows, which should more accurately reflect the time-value
of money principle.
- Project appraisal should be based on cash flow
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 PROJECT CASHFLOW SETTING

• How to prepare a project cash flow statement

§ Direct:
- Net cash flow = Cash in - Cash out
- Investing activities, Financial activities, Business activities
§ Indirect (accounting method)
- Net cash flow from operating activities is adjusted from profit to
- Investment activities, financial activities by direct method
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 PROJECT CASHFLOW SETTING

• Steps to calculate the net cash flow of the project:

- Operating cash flow = Net sales

- Operating cash out = Operating expenses + maintenance + taxes

- Net Operating Cash Flow = Operating Cash Inflow – Operating Cash Flow out
- Project's Net Cash Flow = Net Operating Cash Flow – Investment Expense

- Creditor's cash flow = Interest payment + Principal payment – Debt disbursement

- Owner's Cash Flow = Project's Net Cash Flow – Creditor's Cash Flow

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 PROJECT CASHFLOW SETTING
• Convention
- Usually use the direct method
- All revenues and expenditures are generally assumed to arise at the end of the
year, unless otherwise stated at the beginning of the year
- The start year of the project is always year 0

- The year of liquidation of the project is not necessarily the year of the end of
the project, usually spend a year n + 1 to liquidate the entire project
- Loss carry forward à Included in taxable income for the following years
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PROJECT CASHFLOW SETTING

- Land cost: Cannot calculate depreciation allocated according to rental

value, opportunity cost value of land (except for deductions specifically
allocated for the project)
- According to the principle of prudence, for projects not in the real estate
sector, the added value of real estate price increases can be ignored.
- Remaining value at the end of the project: Fixed assets that have not been
fully depreciated or liquidated, Liquidation of land, Liquidation of inventory,
Liquidation of receivables, payables, and reserve cash.
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PROJECT CASHFLOW SETTING
- Inventory: Inventory (raw materials, fuel, semi-finished products, goods) needs
to be reserved to maintain regular and continuous operations of the project.
- Inventory arises because production output or goods purchased during the
period and output often do not coincide
- In case there is inventory, it should be noted to calculate cost of goods sold
(can follow FIFO and LIFO method)
- In calculating project cash flows, changes in inventory are included in
adjustments to accounts receivable and payable.
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PROJECT CASHFLOW SETTING
• Tools for direct project cash flow
§ Revenue table

§ Investment plan table

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 PROJECT CASHFLOW SETTING
§ Depreciation schedule table

§ Debt repayment plan table

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PROJECT CASHFLOW SETTING
Profit and loss accounting table

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 PROJECT CASHFLOW SETTING

§ Accounts Receivable Table

- Receivables come from revenue but misappropriated capital

- Differences in receivables (which is the receivable in the period)

= Receivables at the end of the year – Receivables at the beginning of the year
- When entering the cash flow table, there should be a minus sign

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 PROJECT CASHFLOW SETTING
§ Table of accounts payable
- Payable comes from expenses but can be capital intensive
- Differences in payables (which is payable in the period)
= Payable at the end of the period – Payable at the beginning of the period
- When entering the cash flow table, there should be a minus sign

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 PROJECT CASHFLOW SETTING

§ Cash reserve table

- The project needs to have a certain amount of funds in order to carry out daily
transactions
- Reserve cash costs opportunity and increases project cash flows

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PROJECT CASHFLOW SETTING
Summary table of cash flows (IF – OF – NCF) – Calculated for each project year

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VIEWPOINTS OF BUILDING CASH FLOW

- A viable project must convince the investor and stakeholders

- The evaluation of project performance on the basis of cash flow
analysis must be based on different points of view
- Depending on the point of view of cash flow construction, the handling
of some cash flow items will also be different

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VIEWPOINTS OF BUILDING CASH FLOW
❖The diagram summarizes the 3 points of view of cash flow
construction: Finance – Budget – Economy

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 VIEWPOINTS OF BUILDING CASH FLOW
v Financial view: Net cash flows are based on financial prices of inputs and outputs. Consists
of 2 views: TIPV and AEPV
• Total Investment Point of View (TIPV)
- Investment capital includes both equity and borrowed capital
- The project cash flow is the total investment cash flow (TIPV): There are 2 parts, the cash flow
of the owner (EPV) and the cash flow of the creditor. The creditor is always the first recipient of
the cash flows (through interest) and the Investor will be the later recipient of the cash flows.
Evaluating the project's efficiency and ability to repay loans Bank's point of view
- Include interest expense in profit calculation
- Taking into account the borrowing rate in the cost of capital

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 VIEWPOINTS OF BUILDING CASH FLOW

• All Equity Point of View (AEPV)

- Assume the investment capital has only equity, no debt
- Evaluate the effectiveness of the project à Investor's point of view
- Do not include interest expense in the profit calculation
- Does not take into account the tax shield in the cost of capital

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 VIEWPOINTS OF BUILDING CASH FLOW

v Government budget view

- If the government has to provide funding, subsidies, or concessional
loans The government must withdraw from the state budget
- Sources of revenue to the state budget through taxes, fees, capital
returns and loan interest
à Building a cash flow table from the point of view of the state budget

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 VIEWPOINTS OF BUILDING CASH FLOW
v Economic point of view
- View the entire project capital as the overall capital of the economy, an accounting unit
- The economic value of all the outputs and inputs of the project must be calculated à Types of
taxes, subsidies, loans, debt repayment
- The positive and negative externalities of the project must be taken into account
v Social perspective (income distribution)
- Calculate the net financial benefit for the elite group in society after deducting their opportunity
costs
- The project must be pareto efficient – not sacrificing the interests of one group for the benefit of
another

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