Getting the cash flows right

Accounting Ahead | Original study resource | accountingahead.com.au

Getting the cash flows right

MODULE 4 | PART C.3.2 | STUDENT COMPANION

Worked example

Include Exclude

Initial investment (refined as estimates firm up) Sunk costs already paid (e.g. a past feasibility study)

Risk reserve within estimates (scope changes priced

separately)

Interest and other finance costs - already in the discount

rate

Working capital: outflow at the start, inflow when

released

Depreciation itself - a non-cash expense

Tax on revenues; tax deductions on expenses

Tax saving from depreciation (tax rate x annual write-off)

Residual value, and tax on any gain or loss on disposal

Formulas and rules

Item Rule

Depreciation tax saving Tax rate x tax depreciation for the year

Project life Based on how long the output earns cash - not on tax write-off periods

Residual value Can be negative (e.g. site rehabilitation); matters most for short projects

Forecasts Revenue: market growth, share, competitors, prices. Reconcile forecast and

actual cash flows during the project

STRATEGIC MANAGEMENT ACCOUNTING | M4 PART C.3.2 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Question 1

A laundry company is evaluating new machines costing $180,000, written off for tax over three years at a 30%

tax rate. It has already paid $12,000 for a consultant's report. The project needs $25,000 of extra working

capital, released at the end. The machines will be financed by a loan costing $9,000 a year in interest, and are

expected to sell for $15,000 at the end of year three. Which items belong in the NPV cash flows, and what is the

annual tax saving from depreciation?

STRATEGIC MANAGEMENT ACCOUNTING | M4 PART C.3.2 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Worked answers

MODULE 4 | PART C.3.2 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Worked answer

Item Treatment

Machines $180,000 Include - year 0 outflow

Consultant's report $12,000 Exclude - sunk cost

Working capital $25,000 Include - year 0 outflow; year 3 inflow

Loan interest $9,000 a year Exclude - in the discount rate

Residual value $15,000 Include - year 3 inflow (plus any tax on a gain)

Depreciation tax saving 30% x $60,000 = $18,000 a year, years 1-3

Depreciation itself never appears as a cash flow; only its tax effect does.

STRATEGIC MANAGEMENT ACCOUNTING | M4 PART C.3.2 | WORKED ANSWERS

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