1. Process of Developing Project Cash Flows
Lecture No.33
Chapter 10
Contemporary Engineering Economics
Copyright © 2016

2. Example: When Projects Require Only Operating and Investing Activities
Given: Financial Data
Investment: $125,000
Project life: 5 years
Salvage value: $50,000
Annual labor savings: $100,000
Annual manufacturing costs
Labor: $20,000
Materials:$12,000
Overhead:$8,000
Depreciation method: 7-year MACRS
Income tax rate: 40%
MARR: 15%
Find: Determine the project cash flows

4. Profitability
NPW of the investment if MARR is 15%:
PW(15%) = $43,152

5. When Projects Require Working-Capital Investments
What is working capital?
Definition: The amount carried in cash, accounts receivable, and inventory that is available to meet day-to-day operating needs.
Working capital is used for non-depreciable assets (like raw material inventory, labor salaries, safety stock inventory…).
So, no depreciation is allowed on working capital expenditures.
You need to invest in these assets before you receive your first revenue stream.
When the project ends, working capital will be fully recovered!

6. Example: When Projects Require Operating, Investing Activities and Working Capital
Suppose now that $23,331 is required as working capital for the previous example.
You are NOT expected to know how $23,331 is obtained.
However you are responsible for how you would use this amount in the project cash flow (next slide)

8. Profitability Changes in Profitability
NPW without the Working Capital Requirement
PW(15%) = $43,152
NPW with the Working Capital Requirement
PW(15%) = $31,420
Difference: $11,732 (lost earnings due to funds tied up in working capital)

9. When Projects Are Financed with Borrowed Funds
Key issue: Interest payment is a tax- deductible expense.
What needs to be done
Once a loan repayment schedule is known, separate the interest payments from the annual installments.
What about principal payments?
As the amount of borrowing is NOT viewed as income to the borrower, the repayments of principal are NOT viewed as expenses either—NO tax effect.

10. Now suppose that half of the investment is financed.
Amount financed: $62,500
Financing rate: 10% per year
Annual installment: $16,487 or, A = $62,500(A/P, 10%, 5)
End of
Year
Beginning
Balance
Interest Payment
Principal Payment
Ending 1
$62,500
$6,250
$10,237
$52,263 2
52,263
5,226
11,261
41,002 3
4,100
12,387
28,615 4
2,861
13,626
14,989 5
1,499
14,988
$16,487

12. Effects of debt financing on profitability
NPW with debt financing
PW(15%) = $44,439