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Estimation of Cash Flow in Capital Budgeting problems

Estimation of Cash Flow in Capital Budgeting problems with solutions. Financial Management notes on formula & solved illustration on Initial Cash Outflow, Subsequent & Terminal Cash Inflow, Incremental Cash Flow In the capital budgeting decision process, cash inflows in the form of raising the funds and cash outflows in the form of interest and dividend payments, are ignored. The cash inflow arising at the time of raising of additional fund results in an immediate cash outflow also when these funds are used to procure the project. As such, there is no net cash inflow. Further, the cost of financing in the form of interest and dividend is truly reflected in the weighted average cost of capital which is used to evaluate the proposals. If the cost of debt or equity (ie, interest or dividends) is deducted from the cash inflows, then this cost of raising fund will be counted twice, first in the cash inflows and second, in the weighted average cost of capital. This is also known as interest Exclusion Principle. The interest payable to the lenders and the dividend payable to the shareholders are cash flows to the supplier of funds and not cash flow from the project. In capital budgeting, the cash flow from the project is compared with the cost of acquiring that project. A particular capital mix, the firm uses to finance the project is a managerial variable and primarily determines how project cash flows are divided between lenders and owners. Thus, neither, the additional funds raised nor the interest/ dividend payable on these funds are treated as relevant cash flows for a proposal. Otherwise, there will be an error of double counting. The general principle is that the investment decision and the financing decision should be considered Separately. In other words, only the operating cash flows of a proposal should be brought into and evaluated in the capital budgeting process. The financial cash flows should be taken as constant and be kept outside the analysis. Initial Cash Outflow = Cost of new plant +Installation Expenses +Other Capital Expenditure+ Additional Working Capital - Tax benefit on account of Capital loss on sale of old plant (if any) - Salvage value of old plant +Tax Liability on account of Capital gain on sale of old plant (if any). Subsequent Cash inflow = Profit after Tax+ Depreciation+ Financial charge (1 - t) Repairs (if any) - Capital Expenditure (if any). Terminal Cash inflow = Salvage value of asset ± Tax on capital gain / loss on sale of asset + Working Capital released.
Cash Flow Estimation in C.B.

Estimation of Cash Flow in Capital Budgeting

Estimation of Cash Flow in Capital Budgeting problems with solutions 1. The cost of a machine is 10, 00,000. It has an estimated life of 10 years after which it would be disposed off (scrap value nil). Profit or Earning before depreciation and taxes (EBDT/PBDT) is estimated to be 2, Read more…

By admin, 3 yearsJune 4, 2022 ago

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