Question

1. describe what cash flow generation is and why it is important for every business to focus on cash flow generation first to keep the business afloat.

2. Consider the following scenario: You are the financial manager of a firm that is contemplating investing in a new project that you expect will generate cash flows of $10,000 per year for five years and then $15,000 per year for another two years. At the end of seven years you expect to sell the project's assets for $50,000. You believe that you should earn at least 14% to compensate the shareholders for the project's risk.

There are specific questions that need to be answered: Explain the process for evaluating this project.

What is the present value of the project's terminal value? What is the most that you should pay for this project?

Is this project consistent with the firm's goal assuming you can invest $25,000 in this project?

What is the primary goal of the firm?

Describe and explain to the reader what the above cash flow generation items are and answer the questions.

Answer 1

Cash flow stands to be the net change underlying the cash position of the company from one period to other period. If there exists more outflows of cash in comparison to inflow then the company will have a negative cash flow. On the other hand if the company has more cash inflow than outflow then there is a positive cash flow. It reflects the ability of the company in creating shareholder’s value at the fundamental level through generation of positive cash flow.

Importance of cash flow generation for business is shown below:

1. Cash is considered as king- positive cash flow is necessary to have a better buying power and stable position for the company. While company at time borrow money, positive cash flow provides protection against foreclosures or loan defaults. It is also necessary to comply with the expenses that are required for smooth functioning of the company
2. Debt survival- when company borrow money for purchase of inventory, equipment and building, there is a need to have positive cash flow to make regular payments towards the borrowed money. Positive cash flow is also required to pay off the debt at a later date.
3. Growth- Cash flow generation is essential to enhance the capabilities and comfort of the business to invest in its development and growth. For instance making investment in technology, renovation of infrastructure, research and development, building of new location and purchase of more inventory and asset requires a company to have positive cash flow generation.