Project Synergy

When a project under consideration creates positive benefits (in the form of cash flows) for other projects that a firm may have, there are project synergies. For instance, assume that you are a clothing retailer considering whether to open an upscale clothing store for children in the same shopping center where you already own a store which caters to an adult audience. In addition to generating revenues and cash flows on its own, the children's store might increase the traffic into the adult store and increase profits at that store. That additional profit, and its ensuing cash flow, has to be factored into the analysis of the new store.

Sometimes the project synergies are not with existing projects but with other projects that are being considered contemporaneously. In such cases, the best way to analyze the projects is jointly, since examining each separately will lead to a much lower net present value. Thus, a proposal to open a children's clothing store and an adult clothing store in the same shopping center will have to be treated as a joint investment analysis, and the net present value will have calculated for both stores together. A positive net present value would suggest opening both stores, whereas a negative net present value would indicate that neither should be opened.

Illustration 6.9: Cash Flow Synergies with Existing Projects

Assume that the Bookscape is considering adding a cafe to its bookstore. The cafe, it is hoped, will make the bookstore a more attractive destination for would-be shopper. The following information relates to the proposed cafe:

• The initial cost of remodeling a portion of the store to make it a cafe, and of buying equipment is expected to be $150,000. This investment is expected to have a life of 5 years, during which period it will be depreciated using straight line depreciation. None of the cost is expected to be recoverable at the end of the five years.

• The revenues in the first year are expected to be $ 60,000, growing at 10% a year for the next four years.

• There will be one employee, and the total cost for this employee in year 1 is expected to be $30,000 growing at 5% a year for the next 4 years.

• The cost of the material (food, drinks ..) needed to run the cafe is expected to be 40% of revenues in each of the 5 years.

• An inventory amounting to 5% of the revenues has to be maintained; investments in the inventory are made at the beginning of each year.

• The tax rate for Bookscape as a business is 40%.

Based upon this information, the estimated cash flows on the cafe are shown in Table 6.8. Table 6.8: Estimating Cash Flows from Opening Bookscape Cafe

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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