Question

1. Identify and describe two incremental cash flows from a proposed project such as expanding a product line or launching a new product or service.

2. Define the payback, net present value, internal rate of return, and profitability index method

Answer 1

1) An incremental cash flow refers to additional cash flow that the company makes by undertaking a new project that could be expanding a product line or launching a new product or service. An positive incremental cash flow means company's cash flow will increase with acceptance of the project. There would be incremental cash flow for the company by way of increase in sales by expanding a product line or launching a new product or service.

2) Payback Method : Payback method is use to determine the period of time taken to recover the cost of investment. For example, If Mr A investments in a project which cost $500000 and the cashflow from project is $100000, the payback period would be 5 yrs since it would take 5yrs to recover $500000. ($500000/$100000).

Net Present Value : Net Present Value method refers to difference between the present value of cash inflow and present value of cash outflow over a period of time. The method is used to analyse the profitability or to make decision whether the project should be undertaken or whether it is profitable. If net present value is positive the project will be profitable for the company and negative net present value is not a profitable project.

Internal Rate of Return : Internal rate of return is the discount rate that makes the net present value of all cash flows from a project equal to zero. It is used to determine the profitability of the project. If the internal rate of return exceeds the company's required rate of return than the project is acceptable, if internal rate of return is less than the company's required rate of return that the project is not acceptable.

Profitability Index Method : Profitability Index is an index which is determined by dividing projects Present value of cash inflow by Initial investment. An index of less than 1 refers to the present value of cash inflow is less than the cost of investment. An index of more than 1 would be profitable for the project.