Project Management
Financial Analysis
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Presented to : Prof. Shyam Patil
What is financial analysis?
Financial analysis refers to an assessment of the
viability, stability and profitability of a business,
sub-business or project.
Looks at capital cost, operating cost and operating
revenue.
Comparing the costs and benefits over time to
determine whether a project is profitable or not.
Significance of financial analysis
FA primarily deals with interpretation of
data incorporated in financial statement of a
project.
To find the attractiveness of project to
secure funds.
To check whether the project will be able to
generate enough economic value.
Financial
Analysis
Steps in conducting a Financial Analysis
Identify the costs
Identify the benefits
Performing financial analysis (Cost vs Benefit)
Assess the financial indicators to determine if the
project is financially favorable
Defining Cost
By By By
There are different ways of defining costs: By
functio behavio
type n time r
●
Capital
●
Developm ●
Recurri ●
Variab
ent Cost ng Cost
Cost ●
Operation le Cost
al Cost
●
Non
●
Operati recurrin
●
Fixed
●
Maintena
ng Cost nce Cost g cost Cost
Identifying the Benefits
Identify the benefits that the project will provide,
and the value that can be assigned to each benefit.
Tangible Benefits
Intangible Benefits
Performing a Financial Analysis (Cost vs.
Benefit Analysis)
Step 1: Identify the Sources of Cash Flows (Inflows
and Outflows).
Step 2: Estimate the Magnitude of Specific Cash
Flows
Step 3: Chart the Cash Flows
Step 4: Calculate the Net Cash Flow Using an
Agreed-upon Discount Rate
Step 1: Identify the Sources of Cash Flows
Project execution Cash outflows as well as
inflows
Cash inflows ??
Eg. Increase in revenue, reduction in production cost
etc.
Cash outflow ??
Eg. Cost of project itself or increase in operating cost
due to project
Step 2: Estimate the Magnitude of Specific Cash Flows
Estimating cost is not always straightforward job.
Eg. Can you give money value to following :
Increased output due to enhanced employee satisfaction
Improvement in vendor delivery reliability
Increase in user comfort or convenience
Rely on historic data or benchmark data for
estimating these factors.
Step 3: Chart the Cash Flows
Prepare a chart of your estimations.
Chart all cash outflows and inflows year by year
useful life of the project.
Allowance for the time value of money.
Step 4: Calculate the Net Cash Flow Using an Agreed-upon Discount
Rate
Value of a dollar in the future is less than the value
of a dollar today.
Formula for discounted cash flow :
NPV, IRR and Payback Period can be calculated.
Assess the Financial Indicators
Payback period
Net Present Value (NPV)
Internal Rate of Return (IRR)
Sensitivity Analysis
Payback period
The payback period is the length of time taken for the inflows
of cash (i.e. revenue) to equal the original cost of investment
Measures the length of time it takes for a project to repay its initial capital cost:
EG: Suppose a project involves a cash outlay of Rs 600000 and generates cash
inflow of Rs 100000, Rs 150000, Rs 150000, and Rs 200000, in first ,second, third
and fourth years respectively,its pay back period is 4 years because the sum of cash
inflows during the 4 years is equal to the initial outlay.
Acts as a proxy for risk: the shorter the payback period, the
lower the risk
The weakness of the payback period is that it does not
consider the time value of money.
Net present value (NPV)
The NPV of a project is the sum of the present values of all the
cash flows– positive as well as negative—that are expected to
occur over the life of the project.
Calculating the NPV answers the question How much money
will this project make (or save)?
NPV = Cash flow - initial investment
(1 + r)n
Where , r = Discount Rate (10%)
n = Number of Periods
year Cash flow
0 1000000
1 200000
2 200000
3 300000
4 300000
5 350000
NPV= 200000/(1.01) + 200000/(1.01)2 + 300000/(1.01)3 + 300000/(1.03)
+ 350000/(1.01)5 - 1000000 = -5273
If NPV is POSITIVE (Present Value of Future Cash Flows GREATER than Initial
Investment), APPROVE Opportunity (Value justifies Capital Outlay)
If NPV is NEGATIVE (Present Value of Future Cash Flows LESS than Initial Investment),
REJECT Opportunity (Value insufficient to justify Capital Outlay)
Internal rate of return (IRR)
The IRR of a project is the discount rate which makes its NPV
equal to zero
Calculating the IRR answers the question: How rapidly will
the money be returned?
It’s a calculation of the percentage rate at which the project
will return wealth.
Investment = Cash Flow
(1 + r)n
Where , r = internal rate of return
n = life of the project
In NPV calculation discount rate is known , while in
IRR calculation, we set the NPV equal to zero and
determine the discount rate that satisfies the
condition
Year 0 1 2 3 4
Cash (100000 ) 30000 30000 40000 45000
flow
The IRR is the value of r which satisfies the following
equation:
100000 = 30000 + 30000 + 40000 + 450000
(1 + r)1 (1 + r)2 (1 + r)3 (1 + r)4
We find the value of r by trial and error method.
The decision rule for IRR is as follows
Accept: if the IRR is greater than the coc.
Reject: if the IRR is less than the coc.
Sensitivity Analysis
Projects do not always run to plan. Costs and benefits estimated
at an early stage of a project may indicate a profitable project, but
this profit could be eroded by an increase in costs or a decrease
in the value of the benefits (the revenue).
Sensitivity analysis provides a means of determining the
financial impact of this type of fluctuation.
By entering an anticipated percentage increase in costs or
decrease in revenue the financial impact on the project can be
identified by looking at the change to the NPV or IRR measures.
