Investment Cash Flow (FCI)
The investment cash flow (FCI) is the change in capital from the difference between the inflows and outflows of cash from investments in financial instruments, generally short-term debt and easily convertible into liquidity, capital expenditures associated with the investments, purchase of machinery, buildings, investments and acquisitions.
To build an investment project and calculate its cash flow, the following aspects must be taken into account:
- Stages of the investment project in which you want to calculate the cash flow.
- The information you want to obtain when evaluating the project.
- The objective pursued by investing resources.
The evaluation of a project seeks to determine the profitability of the investment in it, through the determination of the discount rate used to update the cash flows.
Evaluation of a project
The evaluation of a project can be expressed in many different ways, in monetary units through the net present value (NPV), as a cost-benefit ratio, as a percentage through the internal rate of return or IRR, or as a calculation of how long it may take to recover the investment.
The two economic indicators most used by financial experts for the valuation of an investment project are the NPV and the IRR.
NPV is based on the circumstance that the value of money changes over time. With very little inflation, a euro today can make you buy less than a euro a year ago. The NPV allows to know in terms of today's euros the total value of a project that will last for several months or years, and that can combine positive and negative flows.
In turn, the NPV allows deciding whether a project is profitable (NPV greater than 0), not profitable (NPV less than 0) or indistinct (NPV = 0), based on the rate that has been taken as a reference.
NPV> 0; profitable
NPV = 0; indifference
NPV <0; not profitable
On the other hand, the IRR determines what is the discount rate that makes the NPV of a project equal to zero and is expressed as a percentage. It is the maximum interest rate at which it is possible to borrow to finance the project without incurring losses.Comparison between NPV and IRR
Let's see an example of calculating NPV and IRR and investment cash flows.
An investment project requires an initial outlay of € 10 million and is expected to generate profits between the 1st and 6th year. The discount rate applied to investment projects with similar risks is 10%.
In the attached table we have calculated the net present value of the investment project (NPV) through the following formula:
Vft = Cash flow in period t.
IRR = Discount rate
I0 = Initial investment
The NPV is positive (1,646 million euros), therefore the investment is acceptable.
On the other hand, if we want to calculate the IRR to see if it is higher than the discount rate of the sector, calculated in the example by a value of 10%, we will set the net present value to zero to see if the project is interesting.
NPV = 0
If we solve for ie, we obtain the interest rate represented by the IRR, this is the profitability expressed as a percentage of the investment.
i e = 14.045%. The project is interesting.
On many occasions, the Excel tool is used to calculate the internal rate of return due to the speed and ease of evaluating investment projects:Statement of cash flows Financial cash flow Operating cash flow