3.1 Cash Flow Analysis I
NPV and IRR
1 + r 1 + r
Net Present Value NPV I
Tahun
Arus Kas Bersih
Arus Kas Keluar
Perjanjian Keuangan Closing
Sank costs
t = 0 t = 1
t = 2 t = 5
t = 10 t = 20
t = 30 t = 40
Present Value
Present value arus kas keluar t=2
Present value arus kas masuk pada t=10
PV = - CF
2 2
PV = CF
10 10
Contoh
Sank cost tidak mempengaruhi nalisis
arus kas sebab tetap akan terpengaruh oleh
keputusan investasi Nilai Sisa
1 + r CF
10
1 + r 1 + r
-
CF
2
=
-
CF + + +
+ +
+
-
CF
1
1 + r 1 + r
1 + r
CF
42
1 + r
Net Present Value NPV II
1 2
10
=
Σ
42 t = 0
CF
t t
Present value arus kas keluar pada t=2
Present value dari kas masuk pada t=10
PV
2
=
-
CF
2 2
PV
10
= CF
10 10
PV =
-
CF
Present value arus kas keluar pada t=0
Negative karena merupakan arus
kas keluar
Positive karena merupakan arus
kas masuk Present value dari arus kas masuk dan arus kas keluar
arus kas bersih adalah:
NPV = PV + PV
1
+ PV
2
+ PV
3
+
+ PV
42 42
As long as this value is positive, the project will produce more cash than necessary to repay debt and dividend.
Net Present Value NPV III
Implikasi
NPV Positif: proyek akan menghasilkan nilai lebih banyak dari nilai yang dibutuhkan untuk membayar hutang dan dividend untuk pemegang
saham sehingga proyek dengan NPV positif sebaiknya diterima
NPV 0: proyek akan menghasilkan nilai yang sama dengan nilai hutang dan dividend yang digunakan untuk mendanai proyek
NPV Negatif: proyek tidak dapat menghasilkan kas yang cukup untuk membayar biaya modal kepada kreditur dan pemegang saham
Kelemahan NPV adalah hanya menghasilkan nilai absolut
Investasi 1 million dan 1 thousand secara teoritis dapat menghasilkan NPV yang sama
Based on: Financial Management, Eugene F. Brigham and Michael C. Ehrhardt, 2008
1 + r
Internal Rate of Return IRR
Metode
IRR tingkat diskonto yang mengasumsikan NPV=0
Implication
IRR is useful when investors assess the project against their hurdle rate, which is a cost of capital.
IRR Hurdle Rate: the project will produce more cash than the necessary
amount to repay debt and deliver dividend to shareholders.
IRR = Hurdle Rate: the project will produce the exact amount of cash to
compromise investors’ cost of capital.
Weak points of IRR
It applies the project’s IRR to the reinvestment of cash in flows
When there are more than one change from cash out-flow to cash-in flow, or from cash-in flow to cash out-flow in the projection, the value of IRR are
more than one: calculator would simply indicate “error”
IRR =
Σ
= 0
N t = 0
CF
t t
Based on: Financial Management, Eugene F. Brigham and Michael C. Ehrhardt, 2008
Future value of all cash in flows Present value of all cash out flows
Modified Internal Rate of Return MIRR I
Year
Free cash flow
Cash out flow
Financial Agreement Closing
Sank costs
Present Value Future Value
1 + MIRR =
42
← Cost of capital Cost of capital →
1 + r
t
1 1 + r
N-t
Method
MIRR is defined as the discount rate that forces the present value of cash in flows CIF to equal the present value of cash out flows COF.
Implication
MIRR is better than IRR because it reinvest the cash-in flow by using the cost of capital which is more realistic. Thus, MIRR tells more accurate
profitability of the project.
MIRR Hurdle Rate: the project will produce more cash than the necessary amount to repay debt and deliver dividend to shareholders.
MIRR is better than IRR because it allows more than one changes in plus and minus signs in cash flow projection.
Σ
= 1 + r
N
CIF
t
1 + r
Modified Internal Rate of Return MIRR II
1 + MIRR FV of cash in flows
t = 0 N
COF
t t
t = 0 N
1 + MIRR
Σ
N - t
PV of cash out flows =
N
Based on: Financial Management, Eugene F. Brigham and Michael C. Ehrhardt, 2008
Σ
1 + r
t
Σ
Profitability Index PI
Method
PI is another way of using NPV by dividing PV of future cash flow by initial investment.
Implication
PI tells the relative profitability of the project by indicating the value of the future cash flows par dollar of initial investment. When PI 1, the project
should be accepted. When PI = 1, this basically means NPV = 0 and MIRR = Hurdle Rate.
PI = = Initial investment
PV of future cash flows
42 t = 4
CF
t
1 + r
t
t = 0
CF
t
1 + r
t
Σ
3
PI = = Initial investment
PV of future cash flows
N t = 1
CF
t
CF
Generally:
For the example cash flow projection:
Based on: Financial Management, Eugene F. Brigham and Michael C. Ehrhardt, 2008
100 500
Comparing two projects with NPV and IRR
-1000 100
300 400
-1000 600
400 300
Project A Project B
NPV: 78.82 IRR: 14.5 MIRR: 12.1 PI: 1.08
NPV: 49.18 IRR: 11.8 MIRR: 11.3 PI: 1.05
Cost of capital: 10 Cost of capital: 10
t t
200 100
300 400
-100 NPV
r
5 10
15
7.2 11.8 14.5 49.18
78.82
A conflict between NPV and IRR when: 1 Project size differences exist
2 Timing differences exist below crossover rate.
Take NPV rather than IRR. The logic is That NPV selects the project that adds
most to shareholder’s wealth.
Project A Project B
Crossover rate
Based on: Financial Management, Eugene F. Brigham and Michael C. Ehrhardt, 2008
NPV of FCF for the entire project life NPV of FCF during the life of the debt
Annual debt service principal and interest payments
Other Important Indicators
Debt service coverage ratio
Loan life coverage ratio
Project life coverage ratio
Debt-to-equity ratio =
=
=
=
Outstanding debt Annual FCF
Outstanding debt
Outstanding equity Outstanding debt
or NPV
P2
=
-
CF + + +
Decreasing DebtEquity Ratio
For calculating NPV for a project within a company or for a company’s valuation, generally WACC weighted average cost of capital is used.
In case of project finance the outstanding debt constantly declines and debtequity ratio keeps changing throughout the project life.
NPV
P1
=
-
CF + + +
+
[1 + R
f
+ β
a
x R
p
] NOPAT
2
+ tK
D
D
2
NOPAT
1
+ tK
D
D
1
[1 + R
f
+ β
a
x R
p
] 1 +
WACC
n
CF
n
1 +
WACC
2
CF
2
1 +
WACC
1
CF
1
Issues on Cost of Capital I
1 2
n
in which weight of debt is constantly adjusted WACC =
weight debt x cost debt1 – T +
weight capital x cost equity
1 2
[NOPAT: Net Operating Profit After Tax, t: tax rate, K
D
: debt cost, D: debt outstanding, R
f
: risk free rate,
β
a
: asset beta, R
p
: risk premium]
Tax shield adjustment
1 +
WACC
CF
n
1 +
WACC
CF
2
1 +
WACC
CF
1
NPV
C
=
-
CF + + +
+
1 2
n
Based on: Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows, Richard S. Ruback, 2000
Issues on Cost of Capital II
Reliability of CAPM in Project Finance Situation
Both NPVP1 and NPVP2 in the previous slide involve the concept of CAPM capital asset pricing model to get debt, equity and asset beta,
which would not work appropriately in case of project finance for several reasons:
A country where project is located may not have integratedefficient market
Data would be not available for market risk premium
An ideal instrument represents the risk free rate would not be available
CAPM may not able to incorporate all risks associated with the project
CAPM does not consider asymmetric down side risks
Required return on debt may different between construction and operating periods
What if there is single purchaser located in other country?
What to do?
Based on: Project Finance, Aditya Agarwal and Sandeep Kaul
3.2 Cash Flow Analysis II