What Are the Relevant Cash Flows?
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1) What are the relevant cash flows?
The relevant cash flows are the inflows and outflows of economic resources into or out of the business, meanwhile as a general principal cash flow can be in the form of expenses and revenues generated by the business. However, the relevant cash flows are the cash flows that are related to a specific investment project. Further, in order to be relevant, the cash inflow and cash outflow must arise in the future, additionally; the cash flow must be incremental in order to be relevant to a specific investment decision. Meanwhile, the incremental mean that they will only be relevant if their inflow or outflow depends on the decision being made.
1. The cash inflows and outflows that occur in the future are incremental and after tax.
2. Those that are specific to the Hola Kola Investment.
3. Used for capital investment appraisal purposes
1. expected revenue from the project
2. interest charges
3. potential value of the annex that is unoccupied
4. working capital
5. adjustments for non-cash charges such as depreciation
How shall we treat
a) Consultant’s market study costs
consultants study market cost are R 5 Million Rands but these are irrelevant cost
The consultants cost of market study constitutes the two month period prior to the start of investment project. Although the study cost was necessary and relevant for feasibility analysis and cost value proposition, however, it wont be considered while making the investment decision because:
1. it has occurred in the past and the study has already been completed
2.Outflow of cash has already taken place
3.The acceptance and rejection of the project will not reverse the cost
b) Potential value of unoccupied annex?
Potential rental Value of the unoccupied annex is R60000 per a year
1. The unoccupied annex was built years ago by Tumelo’s father when he planned to venture into gourmet food
2. The annex has been vacant ever since it was built as Tumelo’s father died before he could execute his plan
3. Tumelo recently received an offer to lease out the space for R60000.00 a year. This the opportunity cost of not being able to let the annex rented out and earn the rental income becomes a relevant cost for investment decision.
c) Interest charges
Interest charges on a loan are 16% p.a and the WACC is 18.2% of capital for this project. The WACC includes the cost of debt and cost of equity, henc it is unnessasary to include the interest again.
d) Working capital
The cash inflow and outflow must be incremental in order to be relevant to the investment decision. The incremental working capital will be deducted, hence they should be included in the evaluation.
2) Should we consider the erosion of the existing product – the regular hamburgers – in the analyses? Why/ why not?
The erosion cost will have a negative effect on the companies overall earning.
because the cost are substantial(800000p/a) they have an effect on the projects NPV and are therefore relevant to our analysis.
Decrease of R800000 p/a of after tax