Question

1. When evaluating potential investment opportunities, is it better to focus on the profits or the cash flows generated from a potential investment opportunity? Explain!

Answer 1

When evaluating potential investment opportunities,it is better to focus on cash flows generated by Investment opportunity .This is because Non cash items like depreciation are also considered while calculating profits but in case of cash flows ,we consider only tax effect of depreciation and therefore Cash flow analysis tells us the true picture whether particular project will be beneficial or not .Also ,Profits analysis does not clearly tells us about the liquidity of the project.

The most commonly used methods or techniques which evaluates potential Investment opportunity on the basis of cash flows generated by opportunity are Net present value ,Internal rate of return ,Modified internal rate of return , Profitability index ,Discounted payback period etc .