Question

Assuming you are the Chief Financial Officer (CFO) of the firm you chose in week 1, state your company's name and explain why you would focus more on cash flows rather than accounting profits in making your capital-budgeting decisions? Why are you interested only in incremental cash flows rather than total cash flows?

Answer 1

As a CFO of a firm, we would like to concentrate on the cash flow rather than of accounting profits because in the capital budgeting decisions have to employ cash to the projects who are providing positive net cash increments. In the initial years, it is the non- cash expenses like depreciation which account to losses to the project. So, it is not important in the case of capital budgeting decisions to imply on the profit margin but the Net present value of total cash flows of the project has to be positive.

An incremental cash flow is the cash addition of the operating activities of an organization on the accepted projects. When a project is positive cash flow after discounting the future cash flows to the present cash out-flow, the project is said to be incremental cash project. A positive incremental cash flow comes on to the company if the accepted projects are providing incremental cash flows. The positive incremental cash flow indicates the firm is achieving a positive cash flows and are appropriating the cash to the correct directions in the capital budgeting decision.