Section 15.

3: Applying cash
flow analysis
Submitted by: Pham Ngoc Tuan
Cost saving projects
Cost-savings projects aim to reduce operating costs without adversely
affecting outputs and revenue
The structure of investment in cost-saving project proposals is reflected in
the types of cash flows, as follows:

a) Investment cash flow:
The investment are in new assets or processes. The new assets are better
and more efficient property, plant and equipment or expenditures in research,
manpower or systems. These are cash outflows at the start of project.


B) Operating cash flows.
Operating cash flows are the differences in cost with and without the cost-
savings project after taxes.
Net operating cash flows = Labor cost without Labor cost with project

C) Terminal value cash flows are cash proceeds after tax from the sale of fixed
asset and the recovery of working capital at the end of the projects economic
life.
Terminal cash flow = Scrap value of attachment
The formula of the calculating the cash flow for a cost-saving project.

NCF(CS) = -I
t
+ (OE
0
OE
w
)
t
+ TV
n

NCS(CS): Net cash flow for cost-savings project in period t
I
t
: Investment in period t
OE
0
: Cash operating expenses after tax without the project
OE
w
: Cash operating expenses after tax with the project
TV
n
: Terminal value after tax at the end of the project
T
t
: (1,2,3,n) period of time with the projects life ending in period n.
Vertical Integration projects
a) Investment cash flows:
Vertical integration project require substantial investments in fixed assets.
Working capital and support activities at the start of the project.
b) Net operating cash flows:
Operating cash flows are changes in both revenues and operating costs arising
from the projects.
c) Terminal value cash flows
Terminal value are the cash value of fixed assets and working capital at the end
of economic life of the project.


The formula of the calculating the cash flow for Vertical Integration projects.

NCF(VI)
t
= -I
t
+ (R
w
R
o
)
t
+ (Oe
o
OE
w
)
t
+ TV
n

NCF(VI) : Net cash flows for vertical integration project in period t
I
t
: Investment in period t
R
w
: after-tax revenues with the project
R
o
: after-tax revenues without the project
OE
o
: after-tax operating expenses with the project
OE
w
: after-tax operating expenses without the project
TV
n
: Terminal value of investments at the end of projects life
t
t
: (1,2,3,,n) period of time with the projects economic life ending in period n.

Conglomerate Expansion Projects
Conglomerate expansion projects involve increases in revenues and expenses and
investments in assets or new business.
The cash flow characteristics of conglomerate expansion project are similar to
those of vertical integration projects. There are additional characteristics that
differentiate it from the two other project types
a) Investment cash flows
Investment in a conglomerate expansion project consists of the purchase of entire
business companies, the acquisition of fixed assets, and additional working capital
b) Net operating cash flows
The cash flow of the new business are likewise independent of the exiting businesses.
Otherwise, the financial performance of the new business shall affect the companys overall
cash flows.
c) Terminal value cash flows.

c) Terminal value cash flows.
NCF(CE)
t
= -I
t
+ (R
t
E
t
X
t
) + TV
n

NCF(CE)
t
: Net cash flows independent conglomerate expansion projects
R
t
: Cash revenues before tax in period t
E
t
: Cash expense before tax in period t
X
t
: Total tax in period t
NCF(CE)
t
= -I
t
+ (NI
t
+ D
t
) + TV
n

Ni
t
: Net income of the new business in period t
D
t
: Depreciation expense of the new business

Section 15.4: Computer
Spreadsheets and cash flows
Computer Spreadsheet programs
A spreadsheets is a suitable support to a heuristic decision making approach.
The spreadsheets programs have improved further along the following areas:
Speed in processing and calculations
Increased capacity for mathematical operations
Improved capability for the preparation of graphs, figures and charts
New capabilities for visual presentations
Simplified input procedures and increased use of menu commands.
Expanded storage and file capabilities.
Improved presentation and printed formats
Integration of spreadsheet programs into word processing programs
Ease in converting files from one spreadsheet software to another.
Rules for identifying relevant cash flows
1. Analyze only cash flows
2. Only incremental cash flows are relevant
3. Classify a project into one of three types: cost-savings, vertical integration
and conglomerate expansion.
4. The cash flows generated by the project are found in two areas: in the
project itself and in other parts of the companys business.
5. Investments include fixed assets, working capital and intangible assets
6. Ignore sunk costs when analyzing operating cash flows
7. Include opportunity costs where relevant.
8. Allocated costs are future costs but not incremental costs
9. Estimate terminal values from the sale of assets or the sale of the business
10. pure project cash flows analysis is suitable only for conglomerate expansion
projects that are independent of the companys operations
11. Design computer spreadsheets that closely follow the conceptual and
technical approaches to identifying the relevant cash flows of the project.
Setting cash flows figures in
spreadsheets
Capital budgeting decisions are most suitable for analysis using computer
spreadsheets programs
The first step in computer spreadsheets analysis is to set up the cash flow in a
spreadsheets format. A useful guide in a organizing information for capital
budgeting analysis is to relate three things, namely:
1. The conceptual framework for the capital budgeting problem.
2. The cash flow timeline according to the three stages of the capital investment
project cycle.
3. The spreadsheet format
Spreadsheets for Cost-Savings Projects
Spreadsheet for Vertical Integration
Projects
Spreadsheet for Conglomerate Expansion
Projects
Case analysis: Michael
Jordan, Chicago Bull
by: Pham Ngoc Tuan
Time context:
1996



Viewpoint:
The Bulls owner: Jerry Reinsdorf.

Center problem:

Cash flows that are relevant to the assessment of the Michael Jordan to the
Chicago Bulls.

Objective:

Must: To give the right payment for Michael Jordan for all what he had done
to make Chicago Bull as a NBA Champion.


Want: To be fair to Jordan and give to him the corresponding price.

Areas of consideration:

1) Current situation of the Bull & Impact of Jordan to the Bull:
Current salary of Jordan: $ 4 mil/year
Coach Phil Jackson: $ 2.5 mil/year
Jordan had a close relationship with Jackson and would like to stay the same team
with him
Value of the team:
1985: $ 15 mil
1996: $ 178 mil
30% points score of the Bull for the full season
Payroll for all team (1995 1996)
Ticket: $ 8 /Fan => $ 59.2 mil (1987 1996)
Have Jordan will win 1 of each 4 games
Licensing revenues in 1995 1996: $ 44 mil companied
Areas of consideration:
2) Salary cap and salary of next star Shaquille ONeal
1996 1997: The league have $ 24.3 mil salary cap per team
A team could spend [$24.3mil (all team salary currently) ] for the new
player they want to buy.
Example: New York Knick have 9.5 mil to spend for new player. They can offer
Jordan 34.6 for 3 years contract and average of 11.5 million per season.
Example of other star salary: $55 mil for 4 years contact and average of $13.7
mil per season.
Those figures will be use when comparing salary between offers.
3) Relevant cash flows to assessment impact of Jordan to the team take part of 30% of total
point of the team
In the pass:
Salary in 9 seasons:
1984-85 - $550,000
1985-86 - $630,000
1986-87 - $737,500
1987-88 - $845,000
1988-89 - $2,000,000
1989-90 - $2,250,000
1990-91 - $2,500,000
1991-92 - $3,250,000
1992-93 - $4,000,000
1993-94 - $4,000,000
1994-95 - $3,850,000
1995-96 - $3,850,000
Total of: 28.5 mil
Gate receipts : $59.2 mil for 9 seasons
License revenue : $44 mil increased after Jordan came
Increased value of the team : ( 178mil 15 mil ) = 163 mil
Many other revenue cannot estimated by outsiders such as: local TV revenue, United Center
facilities, national television and cable revenue.
Total known figure : 59.2+ 44 + 163 28.5 mil =237.7 million
Impact of Jordan: 237.7 x 30% = 71.31 million.
4) SWOT analysis


Opportunity:
Appreciate player and pay the
needed amount that match the
ability of the player.
Jordan will retired in 2 years. So that
the contract only for 2 years and
because of that the Bull can lower
the price of Jordan.

Threat:
There are many other team will want
to sign with Jordan with higher price.
They have to compare it carefully

Strength:
The Bull already signed the contract
with the Coach who have good
relationship with Jordan. Its likely
that Jordan will want to stay in same
team with him.
Players cannot move another team,
avoiding disturbance between the
players, coach, manager and/or
organization, avoid distraction.

Weakness:
The salary of remaining players of
the Bull is high. (83.5%). It will be
very high cost if the salary of Jordan
increased too much.

Alternative courses of action.

1. ACA 1: Michael Jordan will be paid 5 mil/year - and paid 25% for his value to the
team Estimated revenue of the Bull in the next 2 years:
Assume that value

1. ACA 2: Michael Jordan will to be paid 30 mil /year without any percentage of other
revenue of the Team.
Recommendation: