Saturday, May 8, 2010


Components of Cash Flows

A typical investment will have three components of cash flows:
  1. Initial investment
  2. Annual net cash flows
  3. Terminal cash flows

1. Initial investment

Initial investment is the net cash outlay in the period in which an asset is purchased. A major element of the initial investment is gross outlay or original value (OV) of the asset, which comprises of its cost (including accessories and spare parts) and freight and installation charges. Original value is included in the existing block of assets for computing annual depreciation. Similar types of assets are included in one block of assets. Original value minus depreciation is the asset’s book value (BV). When an asset is purchased for expanding revenues, it may require a lump sum investment in net working capital also. Thus initial investment will be equal to: gross investment plus increase in the net working capital. Further, in case of replacement decisions, the existing asset will have to be sold if the new asset acquired. The sale of the existing asset provides cash inflow. The cash proceeds from the sale of the existing assets should be subtracted to arrive at the initial investment. We shall use the term Co to represent initial investment.

In practice, a large investment project may comprise of a number of cost components and involve a huge initial net cash outlay.

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