Assignment-2.docx

PRINCIPLES OF CASH FLOW ESTIMATION 

Cash flows should be measured on an incremental basis. In other words, the cash flow stream for a particular project should be estimated from the perspective of how the entire cash flow stream of the firm will be affected if the project is adopted as compared with how the stream will be affected if the project is not adopted. Therefore, all changes in the firm’s revenue stream, cost stream, and tax stream that would result from the acceptance of the project should be included in the analysis. In contrast, cash flows that would not be changed by the investment should be disregarded.

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Cash flows should be measured on an after -tax basis. Because the initial investment made on a project requires the outlay of after -tax cash dollars, the returns from the project should be measured in the same units, namely, after-tax cash flows.

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All the indirect effects of a project should be included in the cash flow calculations. For example, if a proposed plant expansion requires that working capital be increased for the firm as a whole —perhaps in the form of larger cash balances, inventories, or accounts receivable —the increase in working capital should be included in the net investment required for the project.