ABC plc: An example of converting profit to cash flow (adapted from Arnold pp 75-76)
ABC plc is appraising a project that is expected to last for four years. The manager has been told the project will produce a profit of £7,000p.a. It requires an initial investment in machinery of £20,000. This has a useful life of four years and a zero scrap value at the end of the fourth year.
ABC deals with numerous customers and suppliers so cash flows within any particular week are unpredictable. It therefore needs an additional cash float of £5,000 at the beginning of the project. This will not be needed when the project ends.
It is necessary to have a stock of raw materials at the beginning and some cash to fund work in progress and finished goods. £2,000 is needed at the beginning of the project and an extra £1,000 at the end of year 2. It will run down to nil at the end of the project. When the business begins, raw material suppliers will grant additional credit. Creditors will rise by £1,000 over the life of the project and then be paid at the end of the project.
ABC plc has a cost of capital of 12%
• Prepare a schedule of cash flows for this project
• Calculate the net present value of this project
• Decide whether the project should be accepted or rejected
|ABC plc calculation of net operating cash flow | |Time (years) |0 |
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