Thursday, May 6, 2010


Incremental Cash Flows

It is important to note that all additional cash flows that are directly attributable to the investment project should be considered. A cash flow stream is a series of cash receipts and payments over the life of an investment. The estimates of amounts and timing of cash flows resulting from the investment should be carefully made on an incremental basis.

What do we mean by incremental cash flows?

Every investment involves a comparison of alternatives. The problem of choice will arise only if there are at least two possibilities. The minimum investment opportunity, which a company will always have, will be either to invest or not to invest in a project.

Assume that the question before a company is to introduce a new project. The incremental cash flow in this case will be determined by comparing cash flows resulting with and without the introduction to the new project. If the example, the company has to spend 50000$ initially to introduce the project, we are implicitly comparing cash outlay for introducing the project with a zero cash outlay of not introducing the project. When the incremental cash flows for an investment are calculated by comparing with a hypothetical zero-cash-flow project, we call the absolute cash flows.

No comments: