BUDGETS & OTHER FORECASTS: DCF ANALYSIS TO APPRAISE DIFFERENT PROJECTS (BANG FOR THE BUCK)

Net Present Value is widely deployed to perform contrast and comparison among projects, proven the discount rate, the life expectancy and the initial investment value are all the same.

Could I use discount cash flow (DCF) analysis to appraise projects with different discount rates, amounts and life expectancies??? YES! But with a twist....

Remember? COST-->BENEFIT or the old fashioned ratio: BENEFIT/COST??

Read the following projects:

year/project	A	B	C	D	E	F	G	H
0	-2000000	-10000000	-10000000	-10000	-110000	-17200	-1000000	-350000
1	1000000	4000000	0	300	25000	10000	200000	35000
2	1200000	4000000	0	500	25000	10000	206000	35000
3	1400000	5000000	14000000	1200	25000	10000	212180	35000
4				2000	25000	10000	218545,4	42000
5				2000	25000	10000	225101,76	42000
6					25000	10000	231854,81	42000
7					25000	10000	238810,46	42000
8					25000	10000	245974,77	42000
9					25000	10000	253354,02	42000
10					25000	10000	260954,64	42000
11						10000	268783,28	42000
12						10000	276846,77	42000
13						10000	285152,18	42000
14						10000	293706,74	42000
15						10000	302517,94	42000
16						10000	311593,48	42000
17						10000	320941,29	42000
18						10000	330569,53	42000
19						10000	340486,61	42000
20						10000	350701,21	42000
21								42000
22								42000
23								42000
24								42000
25								42000

These are the free cash flows for every venture. Each of them has a unique market discount rate above the Cost of Capital related to our Investment Bank.....What is/was the best project overall??

"The Bang For The Buck" is the answer.....The discount rates are as follow (%): 4, 4.1, 4.2, 4.5, 5, 10, 8, 10

We know the present value for CapEx, Costs and Investment. Now we need the present value for the net cash income.....They must be read as :

A= 3315600.82 , B= 11965766.65, C= 12374420.65, D= 14061.80, E= 193043.37 , F= 85135.64 , G= 2450008.29     H= 2144175.17 and now: the ratios of efficiency:

A= 1.65780041, B= 1.196576665, C= 1.237442065, D= 1.40618, E= 1.7549397273, F= 4.949746349, G= 2.450008290, H= 6.126214771 Why investment F has the same discount rate than investment H? Although, F life is shorter than H, F is a high tech venture while H is a monopolic public transport service
**************************************************************************************************************************************

NOW, HOW TO DRAW A BUDGET: In most countries, forecasting the last financial statements by using Customer's Price Index rate of change is bylaw.....There is a major flaw: this rate is an average of the economy as a whole, so it might no mirror the change rates of your business....The alternative: Ground Zero Budget

The author's favorite method:

1. You should calculate the historical geometric average for the change rate of your incomes (both operational and non operational)

2.Apply down analysis to calculate the share for costs, expenses, profit/loss

....Now you can forecast these variables and to draw an income statement with an expected profit/loss

3. The expected profit/loss goes to the EQUITY section on the Balance sheet and again ....based on historical calculations you must apply down analysis to draw the pending values for the accounts on the equity section and the accounts on the LIABILITIES SECTION....The share for each account and subaccount are defined by the arithmetical average of previous years

For example: total income for your company last fiscal year was $150 million.....The historical geometric average for the change is 15% a year

Total operational costs, CapEx and non operational Expenditure. Down Analysis tells us that the historical average weight of them is 80%

150*1.15 = 172 .5 expected total income for next year and 172.5 * 0.8 = 138 the total expected costs, CapEx and non operational expenditure (taxes have been discounted, already)

expected net profit = 34.5 Down analysis tells us that the historical average weight for profits is 50% of the equity

expected equity = $69 millions down analysis tells us that the historical average weight of equity on the financial structure for this company is 70%

liabilites are 30% = expected $29.57 millions

total asset : $98.57 millions

See you around!

Sources: Kay Giesecke, Dmitry Smelov, David Luenberger, Jorge E. Burbano, Alberto Ortiz & Stanford U.