Cash Flow Statement for a Specific Project
Before you can run NPV on a new project, you need its yearly cash flows. Project cash flows combine three pieces: operating cash flow from the extra sales, the money spent on equipment, and cash tied up in working capital, plus whatever you get back when the project ends.
What you will learn
- Which cash flows count for a project and which ones do not
- How to compute project operating cash flow with taxes and depreciation
- How net working capital goes out at the start and comes back at the end
- How to find after-tax salvage value
- How to lay out a year-by-year cash flow table ready for NPV
The formulas
- Sales − Costs
- Extra revenue and cash costs caused by the project
- Depreciation
- Annual depreciation on the project's equipment
- T
- Tax rate
- Salvage price
- What the equipment sells for at the end
- Book value
- Cost minus accumulated depreciation at the time of sale
- Capital spending
- Cash spent on equipment, net of after-tax salvage when sold
- ΔNWC
- Increase in net working capital (a recovery at the end is a negative change, so it adds cash)
Worked example
A 3-year project needs a $90,000 machine, depreciated straight-line to zero, and $10,000 of extra working capital, recovered at the end. Sales are $100,000 and cash costs $50,000 per year. The tax rate is 25% and the machine sells for $15,000 at the end. Find the cash flows.
- Depreciation = 90,000 ÷ 3 = 30,000 per year
- OCF = (100,000 − 50,000 − 30,000) × 0.75 + 30,000 = 45,000 per year
- After-tax salvage = 15,000 − 0.25 × (15,000 − 0) = 11,250
- Year 0 = −90,000 − 10,000 = −100,000
- Years 1 and 2 = 45,000; Year 3 = 45,000 + 10,000 + 11,250 = 66,250
Answer: Cash flows are −$100,000, $45,000, $45,000 and $66,250 for Years 0 to 3, ready to discount for NPV.
Common questions
How do you calculate operating cash flow for a project?
Take the project's extra sales minus cash costs minus depreciation, apply the tax rate, then add depreciation back. An equivalent shortcut is (Sales − Costs) × (1 − T) + T × Depreciation, where the last term is the depreciation tax shield.
Why is net working capital recovered at the end of a project?
Extra inventory and receivables tie up cash while the project runs. When it ends, the inventory is sold off and customers pay up, so that cash comes back. You show it as an outflow at the start and an inflow in the final year.
How do you calculate after-tax salvage value?
Subtract book value from the sale price to get the taxable gain, multiply by the tax rate, and subtract that tax from the sale price. If the asset sells below book value, the loss saves tax and the after-tax salvage is higher than the sale price.
Are sunk costs and interest included in project cash flows?
No. Sunk costs are already spent whatever you decide, so they are ignored. Interest is also left out because financing costs are captured in the discount rate. Include only incremental cash flows caused by taking the project.