Net Cash Flows for Investments (Cambridge (CIE) A Level Accounting): Revision Note
Exam code: 9706
Future net cash flows
What is investment appraisal?
Investment appraisal is a process to assess the financial viability of a project or a purchase
Methods of investment appraisal use future cash inflows and outflows of the project
How do I calculate the future net cash flows?
Use a table format for these calculations
Each row represents a year
For each year, calculate the proceeds and costs associated with the project
These might be based on the number of units sold
These might be based on percentages of other amounts
Do not include depreciation costs
Remove these costs from the fixed costs if they are included
For each year, calculate the net cash flow by:
adding together the proceeds
subtracting the costs
Include a row for Year 0
This contains the initial costs
The net cash flow is negative for Year 0, but it should be positive for most (if not all) of the other years
Examiner Tips and Tricks
These questions tend to be worth a good number of marks. Take your time, as most marks lost by students are due to numerical errors rather than lack of understanding.
Check carefully whether fixed costs include or exclude depreciation. Depreciation charges should not be included because they do not affect cash flows.
Worked Example
The directors of D plc are considering the purchase of a new machine to manufacture a newly developed product, Product Omega. The directors intend to manufacture the product for only four years, after which the machine will have zero residual value.
The following estimated information is available regarding the project:
Capital expenditure: The new machine will cost $220 000, payable immediately (Year 0). An additional machine upgrade costing $30 000 will be required at the end of Year 2 to maintain production capacity.
Sales volume:
Year | Units |
|---|---|
1 | 3 000 |
2 | 4 500 |
3 | 5 000 |
4 | 2 500 |
Selling price and variable costs:
The selling price will be $80 per unit for all four years.
Direct materials and direct labour will cost $50 per unit.
Fixed costs: Fixed overheads (excluding depreciation) specifically related to the project are expected to amount to $45 000 each year.
Complete the following table by calculating the net cash flow for each year of the project.
Year | Capital expenditure ($) | Revenue ($) | Variable costs ($) | Fixed costs ($) | Net cash flow ($) |
|---|---|---|---|---|---|
0 | |||||
1 | |||||
2 | |||||
3 | |||||
4 |
Answer:
Calculate the revenue and variable costs for each year
Year | Revenue | Variable costs |
|---|---|---|
1 | 3 000 × $80 = $240 000 | 3 000 × $50 = $150 000 |
2 | 4 500 × $80 = $360 000 | 4 500 × $50 = $225 000 |
3 | 5 000 × $80 = $400 000 | 5 000 × $50 = $250 000 |
4 | 2 500 × $80 = $200 000 | 2 500 × $50 = $125 000 |
Calculate the net cash flows for each year by including the capital expenditure and the fixed costs
Year | Capital expenditure ($) | Revenue ($) | Variable costs ($) | Fixed costs ($) | Net cash flow ($) |
|---|---|---|---|---|---|
0 | (220 000) | (220 000) | |||
1 | 240 000 | (150 000) | (45 000) | 45 000 | |
2 | (30 000) | 360 000 | (225 000) | (45 000) | 60 000 |
3 | 400 000 | (250 000) | (45 000) | 105 000 | |
4 | 200 000 | (125 000) | (45 000) | 30 000 |
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