Lecture 19_Financial Study

Lecture 19: Financial Study –
4) Profitability Indicators
Hebatalla Atef Emam, PhD
Email: [email protected]
Outline
I. Undiscounted Profitability Indicators
- Cash Flow Statement
- Payback Period
December 2024 Hebatalla Atef Emam, PhD 2

Components of Feasibility Study
Feasibility
Study
Market Technical Financial Economic

Study Study Study Impact
Study
Other studies might be needed, i.e. Social Study, Managerial

Study, Environmental Impact Study, Legal Study,….etc.

Components of Financial Study
1) Total Investment
2) Financial Structure
Cost of the Project
Financial
Study
3) Economics of 4) Profitability
Operation Indicators
Profitability Indicators
Profitability Indicators
1) Undiscounted 2) Discounted
1.1) Rate of 1.2) 1.3) Payback

Cost/Benefit 2.1) Net 2.2) Net 2.3) Internal
Return Period Present Value Present Value
Ratio Rate of
(NPV) Ratio Return (IRR)
(NPVR)
Income Statement Cash Flow Statement

5
December 2024 Hebatalla Atef Emam, PhD
I) Undiscounted Profitability
Indicators

Cash flow Statement
It is a schedule (statement) that represents the yearly net cash flow
for a certain project.
It is related to the whole lifetime of the project. Thus, it covers

both the construction and the operation periods.
It calculates Net Cash Flow during the whole lifetime of the

project.
Net Cash Flow (NCF) = Cash inflow – Cash outflow
It could be constructed from equity perspective and project

perspective.
Cash flow Statement
Does cash flow statement include

depreciation?

Cash flow Statement
Does cash flow statement include

repayment (installments) of external
sources of finance?

Cash flow Statement
Project (Investment)
Perspective
Equity Perspective
IC, operating
Sales Revenues, cost, marketing
Capital cost, tax
Gains,..etc. payments
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Cash flow Statement
Equity Perspective Investment Perspective
Phase
Cash Inflows Cash Outflows Cash Inflows Cash Outflows
External sources of
finance (loans,
Construction IC zero IC
bonds, supplier
Phase facilities,..)
Negative amount (equity) Negative amount (IC)
Sales Revenues Operating Cost Sales Revenues Operating Cost
Marketing Cost Marketing Cost
Other sources of Other sources
Operation revenues ( i.e. Tax payments of revenues Tax payments
Phase interest on (i.e. interest on
securities, Interest securities,
subsidies, NWC, subsidies,
land…) Installment NWC, land…)
11
Cash flow Statement
Notes on cash flow statement
- Financial cost is not included in cash flow statements, as it
includes depreciation and interest. Depreciation is excluded
from cash flow statements and interest is included only in cash
flow statements from equity perspective.
- NWC and Land are included in cash flow statements as
outflows in the construction phase (part of IC) and inflows in
the operation phase (last year).

Cash flow Statement
 Numerical Example
ABC project has initial cost outlay of 35,000 LE with 1 year of

construction. Its expected annual net profit before depreciation
is 5,000 LE for 10 years. The firm is in a 50% tax bracket.
Calculate the annual net cash flow for the underlying
project.

Cash flow Statement
 Solution
- Given the above information, we will construct the cash flow

statement from investment (project) perspective.
- To be able to get the annual tax payments, we need to get the

net profit before tax which is calculated from the income
statement.

Cash flow Statement
- To get net profit before tax, we need to subtract the depreciation
from the net income figure given in the problem.
- Annual depreciation amount = IC ÷ lifetime = 35,000 ÷ 10 =

3,500.
- Net Profit before tax = 5,000 – 3,500 = 1,500.
- Tax payments = 1,500 * 0.5 = 750.

Cash flow Statement
Y0 1 - 10
Cash inflows:
Annual net profit before
0 5,000
depreciation
Cash Outflows:
Investment Cost 35,000 ----
Tax Payments ---- 750
NCF -35,000 4,250

Payback Period
1.3) Payback (Recovery) Period
 It refers to the number of operation years needed to recover the
IC. It is calculated from the cash flow statement.
 Rule: Accumulated NCFt = NCFt + Accumulated NCF t-1
 Decision Rule: When comparing between various projects, we

choose the one with the shortest payback period.

Payback Period
Numerical Example
If you have the following NCF for two projects, calculate the
payback period for each project and determine which
project are you going to choose.
Years 0 1 2 3 4 5
NCF for
(2,000) 1,000 750 500 0 0
Project A
NCF for (2,000)
500 750 1,000 750 0
Project B

Payback Period
▪ Solution:
▪ For Project A:
Years 0 1 2 3 4 5
NCF (2,000) 1,000 750 500 0 0
Accumulated (2,000) (1,000) (250) 250 250 250

NCF
12∗250
Pay back period for project A = 2 + = 2 years and 6 months
500
of operation…. Project A needs 2 years and 6 months of operation
to recover its investment cost of 2,000.

Payback Period
▪ For Project B
Years 0 1 2 3 4 5
NCF (2,000) 500 750 1000 750 0

Accumulated
(2,000) (1,500) (750) 250 1,000 1,000
NCF
12∗750
Pay back period for project B = 2 + = 2 years and 9 months
1,000
of operation. Project B needs 2 years and 9 months of operation to
recover its investment cost of 2,000.
So, we choose project A as it has the shortest payback period.
Payback Period
▪ Disadvantages
It does not take into consideration the time value of money (as it is an
undiscounted indicator).
It is misleading in case we are comparing between different projects

with the same payback period.
Its decision rule depends on the number of years of recovery of IC

regardless of the percentage of recovery of IC.
It stops the comparison at the years of recovery of IC regardless of

NCF after the recovery.
It isn’t an evaluation technique as it isn’t a measurement of

profitability. Instead, it is concerned with the liquidity of the project. 21
Thank You

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Lecture 19: Financial Study –

- Cash Flow Statement

December 2024 Hebatalla Atef Emam, PhD 2

Market Technical Financial Economic

Other studies might be needed, i.e. Social Study, Managerial

December 2024 Hebatalla Atef Emam, PhD 3

1.1) Rate of 1.2) 1.3) Payback

Income Statement Cash Flow Statement

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It is related to the whole lifetime of the project. Thus, it covers

It calculates Net Cash Flow during the whole lifetime of the

Net Cash Flow (NCF) = Cash inflow – Cash outflow

It could be constructed from equity perspective and project

Does cash flow statement include

December 2024 Hebatalla Atef Emam, PhD 8

Does cash flow statement include

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ABC project has initial cost outlay of 35,000 LE with 1 year of

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- Given the above information, we will construct the cash flow

- To be able to get the annual tax payments, we need to get the

December 2024 Hebatalla Atef Emam, PhD 14

- Annual depreciation amount = IC ÷ lifetime = 35,000 ÷ 10 =

- Net Profit before tax = 5,000 – 3,500 = 1,500.

- Tax payments = 1,500 * 0.5 = 750.

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 Rule: Accumulated NCFt = NCFt + Accumulated NCF t-1

 Decision Rule: When comparing between various projects, we

December 2024 Hebatalla Atef Emam, PhD 17

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NCF (2,000) 1,000 750 500 0 0

Accumulated (2,000) (1,000) (250) 250 250 250

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NCF (2,000) 500 750 1000 750 0

It is misleading in case we are comparing between different projects

Its decision rule depends on the number of years of recovery of IC

It stops the comparison at the years of recovery of IC regardless of

It isn’t an evaluation technique as it isn’t a measurement of

December 2024 Hebatalla Atef Emam, PhD 22

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