Describing Project Cash Flows

When a company purchases a fixed asset such as equipment, it makes an investment. The company commits funds today in the expectation of earning a return on those funds in the future. Such an investment is similar to that made by a bank when it lends money. For the bank loan, the future cash flow consists of interest plus repayment of the principal. For the fixed asset, the future return is in the form of cash flows from the profitable use of the asset. In evaluating a capital investment, we are concerned only with those cash flows that result directly from the investment. These cash flows, called differential or incremental cash flows, represent the change in the firm's total cash flow that occurs as a direct result of the investment.

We must also recognize that one of the most important parts of the capital budgeting process is the estimation of the relevant cash flows. For all examples in this section, however, net cash flows can be viewed as before-tax values or after-tax values for which tax effects have been recalculated. Since some organizations (e.g., governments and nonprofit organizations) are not taxable, the before-tax situation can be a valid base for that type of economic evaluation. This view will allow us to focus on our main area of concern, the economic evaluation of an investment project. The procedures for determining aftertax net cash flows in taxable situations are developed in Section 17.4.

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

Get My Free Ebook


Post a comment