What are relevant cash flows? Why should we only include these cash flows in our capital...

What are relevant cash flows? Why should we only include these cash flows in our capital budgeting analysis? Please also give some examples.

Expert Solution

Relevant cash flows are the incremental cash flows that affect the decision of taking up a project. The incremental cash flows, are any changes that happen to a firm's future cash flows and have a direct impact of taking up the project or not.

Such cash flows should be included in capital budgeting analysis because these cash flows help in predicting a project's cash flow in the future as well as the profitability of a project in the future. Including these cash flows helps make investment decision.

Relevant costs are those whose inclusion affects the decision weather to invest in a project or not. .The cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is accepted. Only those cash flows which will change if we accept the project are relevant cash flows

Sunk costs are costs that have incurred on the past, and cannot be removed these are not relevant cash flows. If money has already been spent on research and development, that should be ignored, only if the money has not been spent yet, then it is relevant.

If our new production is being carried on in the same factory and there no no change in rent then it is not a relevant cash flow but if we have to hire a new space for production, then the rental cost of the new space is relevant.

Opportunity costs are included as the relevant cash flows as these describe the revenue that are lost from moving resources from what they currently in use for. Repair costs are relevant cash flows.

ANY COST OR REVENUE THAT GIVE RISE TO A FUTURE CASH FLOW SHOULD BE INCLUDED IN RELEVANT CASH FLOWS . SO , DEPRECIATION SHOULD NOT BE INCLUDED.

jeff jeffy answered 2 years ago

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