The period over which the net cash flows generated by a project are to be considered is of paramount importance for evaluation purposes. It is necessary to define a specific horizon, since it is entirely unrealistic and impractical to predict cash movements over the entire life of a firm. In project appraisal, part of this difficulty could be mitigated by assuming identical calculation periods for all projects under consideration, but this approach clearly fails to address the core issue. There are divergent opinions regarding the choice of an appropriate horizon. Although, by convention, financial projections are frequently presented for five years in the short term and ten years in the long term, this criterion rests more on practicality or custom than on solid analytical grounds. When synthesizing the many existing viewpoints, it must be acknowledged that a project’s duration may extend until physical wear occurs or economic obsolescence sets in, with the shorter of these two periods being relevant. It is worth noting that while all equipment loses value over time, its economic life persists as long as it remains economically superior to alternative equipment that could be acquired for the same purpose. Thus, when physical life is shorter than economic life, it may be extended through replacement or repair of worn equipment; conversely, new production methods may render equipment unusable well before its calculated useful life has elapsed. For these reasons, even if the aforementioned criteria are accepted as valid, they cannot be treated as mutually exclusive, leaving the issue largely subjective and heavily dependent on the analyst’s judgment. Without diminishing the importance of these considerations, greater temporal precision can be achieved by approaching the problem from another perspective, which requires reiterating a concept repeatedly emphasized: the importance of sales forecasts in all financial projections.
Investment decision and market permanence
The decision to invest presupposes the decision to commercialize, which requires attention to two factors that evolve over time. First, the lifespan of the equipment, which depends on the considerations already discussed. Second, the product’s permanence in the market, which ultimately constrains all other factors. This is one of the most difficult decisions, as it entails, in the words of A. S. Johnson, the need to balance the life of the machinery with the product’s optimal market life. This issue deserves close attention, as it informs the estimation of the product life cycle. Setting aside unpredictable innovations or sudden changes in consumption habits, empirical knowledge of markets can enable analysts to reasonably approximate traditional patterns of market persistence. By combining these views with the previous criteria, it becomes possible to determine whether to extend or shorten the cash flow analysis horizon relative to traditionally accepted periods. C.E.M.L.A. distinguishes three special cases in selecting the horizon. For projects exploiting natural resources available in limited quantities, the chosen period should coincide with the time required to exhaust the deposit based on known reserves. In the case of industrial projects, two methods are suggested. The first is to select a horizon equal to the life of the longest-lived equipment in the plant; the second is to assume an extended period under the hypothesis that equipment will be continuously renewed with identical characteristics and that activities will continue indefinitely. This latter criterion is acknowledged as unrealistic, but it offers practical advantages for evaluation calculations. Finally, the first method is recommended for sectors with high growth rates and rapid market and technological evolution, while the second may be applied to low-growth industries characterized by market stability, slow technical progress, and long-lived equipment.
Synthesized framework of technical, economic, and financial relationships
What follows is a summary prepared from a strictly financial perspective, intended to provide a general outline of the project in terms of decision centers and their impact on the projected statement of sources and uses of funds. It also shows the set of relationships among all partial decisions and the difficulty of altering any one of them in isolation from the overall context. In essence, this global synthesis seeks to convey an understanding of the various aspects involved in preparing an investment project, their interconnections, and their monetary representation in projected revenues and expenditures. For illustrative purposes, the example assumes the establishment of a new firm undertaking an industrial project in the private sector, allowing consideration of all preparatory aspects while referring only to the minimum information required to construct the projected global financing framework. The timing of investments and expected cash flows arises from disaggregating the relevant components in the chronological order of their funding requirements and contributions.
Preliminary considerations
Market
Once the idea of establishing the firm has been proposed, the next step is to verify the market’s capacity to absorb new production and/or increases in existing output. This involves a market study analyzing aggregate demand and supply in order to determine whether, independently of the firm’s specific capabilities—which will be examined later—the project appears to have favorable prospects. This initial, broad assessment provides the necessary green light for subsequent work or definitively rules out feasibility. In special circumstances, this stage may be omitted when the outcome is known in advance, such as in projects aimed at import substitution.
Commercialization
Under this heading are grouped all studies related to the final commercialization of the product. These include not only those that provide projected sales volumes in units and prices, but also those that specify the conditions to be offered to buyers, the systems to be adopted for commercialization, including the definition of any required advertising campaigns, and the estimation of their associated costs.
Scale and technology
Once the preceding issue has been resolved, the product is assumed to be capable of entering the market under defined volume and price conditions. It then becomes necessary to decide on the quantity to be produced and the method of production, both of which emerge from engineering studies. The scale aspect refers to production capacity over a given period and is therefore inherently linked to the choice of technology. Careful consideration must also be given to the relationships among production capacity, market conditions, costs, location, and financial feasibility. For many aspects of the project, the selected technology functions as a central source of induced decisions. Under this heading are included production process methods, their duration, and their associated costs.