Important

points

Notes

Right hand side are real assets . A financial firm may have
financial assets.
Real assets are things which generate value for you. Ex:
machines
This is where action of value creation is happening
Real asset do two things:
Generate cash flow
Go figure out what r is to evaluate

Liabilities side
We finance our idea - u can use equity or debt
To judge a project , we do not see how it is financed.
Instead we look at its cash flow

Decide how may periods

Which point are you standing at ?
Figure out cash flows
Project life depends on how far you are comfortable.
New bizness ,which is unknown, use short horizon.
Familiar idea , we use long duration

Value is always relative - Law of one price ; use market to

figure out the price

Eles to design something similar to coco-cola

without knowing coke's prioce is difficult

Valuation needs:
o

Cashflows

Belongs to the project

Costof capital

WE look at future cash flows and not past

o

Source is Proforma Income statements and

Balance sheets

Income statement is a flow ,like cash flow

o

Belongs to market

To get the flow, take two snapshots like two

google snapshots to see how your city has
changed

Balance Sheet is a snapshot of assets/stocks

Revenue = Price * Quantity

Comes from Income Statement

Price is what people are ready to pay

COGS

SGA

Not Incremental with with the project in

hand

How much more in general am I adding

because of the new project

Depreciation

Use of machinery that can be allocated

to this project.

How much of the car did you use in this

year

Think of it as fake

Operating Profits

Ballonny

It has both real and unreal parts. The

unreal is the Depreciation. We are not
actually spending that money every
month

Cash taxes on Operating Profits

Net operating profits after tax

Add back depreciation

Capaital Ex

This is not a flow

IT is like a snapshot

Capex is the amount of money you spend

on that lasts a while

Likely to be 0,Middle of the project

Comes from B/S. Everything else comes

from I/S

Increases in Working Capital

As soon as you see "Capital" think of B/S

Snapshot is nit a flow. Hence we need to

think of changes ie delta

Cash like a fundamental inventory

Inventory mangement and Working

Capital management is the biggest boom
of internet

Walmart is the king of the working

capital management.

Capital used to manage the system

It is like the grease used to operate the

machine

Cash Flow from operations

Cash Flows Principles:

Estimate all cash flows on an incremental basis

o

Find cash flows with and without the project

Projects are always incremental

Cash flows are always incremental. Think of

what the world would like with the project and
without the project.

Do not forget importance of year 0 and the last year

of the chosen timeline of the project
o

Year 0 : expenditure on buying machinery

You would like to take full tax advantage of

the machinery cost and expense it.

Ideally you would want to save all the tax at

the beginning. Why ?

Because of time value of money.

Working capital ingredients : Some cash for

business + inventory + Account receivable Account Payable

And compounding . The higher the

compound rate , the higher the time
value of money

Cash, Inventory, A/R, A/P all these are

stock . This is a level. The higher the
WC , the less efficient you are.

Both CAPEX and Working Capital are coming

from balance sheet

Accounting issues

Depreciation is important ,because it is made up.

o

Similar non-cash items

Capital
o

Working Capital

CAPEX

Principle 4: Do no mix financing with operations

o

While doing project analysis stay on the assets

side.

Value is generated on the assets of the b/s.

Money is not generated by financing .IT
created by ideas

If you are thinking about financing , you are

not thinking about what adds value to the
projects

The financing part if taken care by "r"

Include the effects of inflation/deflation

o

R has "inflation"

Every item in cash flow statement has

different inflation for different items

Revenue has different inflation

COGS has different inflation

When we do detail analysis, we need to

consider the inflation.

Project 6: Do not compare projects with unequal

lives.
o

Figure out the Terminal value -do not forget

about last year in the project time line

PVA = 23.72 and PVB = 27.72

Make everything equal. I keep buying

machines so that the lives of the to two
horizons are the same. Doing analysis
over 6 years is one way to do.

Per year cost of machine A is 12.76,adjusted

for time value of money and that of M/c B is
10.18 . Hence Machine B is cheaper.

Short-term life span costs less. Project A costs

lesser.

Consider 27.76 as annuity over two

years. Per year cost is determined using
PMT

5%
M/C A

20

20

1.904762

1.81405
9

each of the two

years

Using
PMT

25

25

0.952381

0.90702
9

23.7188
2

Annuit Rs.
y
-12.76

M/C B

27.7232
5

Annuit Rs.
y
-10.18

each of the three Using

years
PMT

Summary

Estimate all cash flows on an incremental basis

Do the c/f analysis on two timelines

Do two analysis

Do not forget importance of year 0 and the

last year of the chosen timeline of the project

Time 0 : Capital - 1. CAPEX , Working

capital.

Always think of changes

Accounting issues are important

Depreciation

Similar when we sell equipment at the

end of the project, we need to think of
terminal value

Working capital

Do not mix financing with operations

Financing is captured in the "r"

Choosing b/w ipad and samsung , do we

think whether ipad is produced with debt
?

Include the effects of inflation/deflation

Inflation is included in r.

Do not compare project with unequal lives

We all love great ideas, but they come very seldom. And
one thing I have against the way we teach, especially at
Business School, is we sell something as, oh, positive NPV
ideas are just floating around for you to just go pluck off
thin air. No, it takes a lot of effort to create value. And the
reason is you gotta be better than the competitor, right.
It's very tough.

Length of time line

Project have finite life . Firms do not have firm life

At Year 10,
o

Sell Inventory

Sell M/C

We are getting back the working capital

Alternately, we are not selling . WE can think of a project

like a firm which goes for ever.
Terminal Value = C11 /(r-g) ; perpetuity
o

Say C10 = 20M

C11 = 20(1+g)

Cash Flow is net of expenses

Problems

Salvage value vs Terminal value

Another way to look at the difference is terminal value
normally refers to the value of an asset or entity at the
end of an investment period, while residual value, or
salvage value, normally refers to an asset at the end of its
useful life.

Depreciation does not matter when we are not paying

taxes

Purchasing inventory on credit will increase the value of a

firm's net working capital.- false

12000
0

-5000

-5000

-5000

-5000

-5000

To calculate NPV of the above investment using Excel ,

exclude year 0 in the set of values. After calculating NPV ,
add the value of year 0.

CAPEX is not taxed , since it is an expense, while taxes

usually are paid on operating profits.