Flashcards in Chapter 4: Market & Private CBA Deck (12):

1

## Market cash flow

### Cash flow for the overall project at market prices, irrespective of who the gainers and losers are

2

## Private cash flow

### Cash flow to the individual investor engaged in the project at market prices, after allowing for loan service costs and after payment of profit taxes

3

## Deriving private cash flow

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Calculate overall market cash flow, then subtract:

- debt/financing inflows and outflows to creditors

- taxes paid to government

4

## Cash flow on equity

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The private cash flow is the cash flow on the investors own funds or "equity"

- market cash flow minus debt cash flow = cash flow on equity (before tax)

- cash flow on equity is what is left over after servicing debt

5

## Deriving market cash flow: concepts to be mindful of

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- Inflation: usual to see constant prices with a real discount rate (otherwise, nominal prices with nominal interest rate)

- Incremental rather than total cash flow ("with" vs "without")

- Depreciation: excluded from cost to avoid double counting. But "scrap value" or "salvage" is added to cash flow in the last year

- Changes in working capital appear under investment costs at beginning and end of project

- Interest on debt excluded from cost to avoid double counting

6

## Deriving debt financing cash flow

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To derive debt financing flow from the borrower's perspective, begin with market cash flows, then:

- add all loan receipts in each period

- subtract all interest payments in each period

- subtract all principal repayments in each period

7

## Deriving IRR on equity

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1. Calculate IRR on market cash flow

2. Calculate IRR on debt financing cash flow

3. Calculate IRR on equity cash flow

8

## Gearing and debt: equity ratio (IRR)

### IRR on equity + IRR on debt = Market IRR

9

## Implications of gearing

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If an investor can borrow on concessional terms a "bad" project can appear "good"

If an investor borrows on unfavourable terms a "good" project can appear "bad"

10

## Calculating after-tax cash flow

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Some items of project cost that do not enter into a project's cash flow directly, affect the net cash flow indirectly though their effect on the project's taxable profits:

- depreciation

- interest on debt

These should be added to the operating costs in the market cash flow for the purpose of calculating taxable profits

Taxes are then calculated as some % of taxable profits and are deducted from the private cash flow to derive the after tax private cash flow

11

## Using private CBA: why would the project analyst who is concerned with the wider public or social interest be concerned with the return on private equity?

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- When the private investor is one of the stakeholders' whose gains are part of the Referent Group net benefits

- Because the policy maker needs to know what's in it for the investor: need incentives? tax concessions? etc.

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