Question

# Conventional versus nonconventional cash flow streams The net annual cash flows for a capital expenditure proposal...

Conventional versus nonconventional cash flow streams

The net annual cash flows for a capital expenditure proposal can be classified as either conventional (normal) or nonconventional (nonnormal). The following table lists the net annual cash flows for five proposed projects.

Project

Year 0

Year 1

Year 2

Year 3

Year 4

A –\$127,520 –\$17,625 –\$23,745 –\$65,340 –\$32,175
B –\$275,150 \$53,125 \$61,135 \$71,900 \$96,325
C –\$135,750 \$28,120 \$43,935 \$52,775 –\$67,835
D –\$317,675 \$70,745 \$88,880 \$95,425 \$13,735
E –\$195,985 \$26,450 –\$49,735 \$39,510 –\$58,275

Which project or projects exhibit a nonconventional cash flow stream?

Project B only

Project D only

Projects A, C, and E

Project A only

Solution:

Conventional Cash Flow Stream:

A conventional cash flow stream is a series of cash flows over a given period of time, wherein a cash outflow occurs only once at the beginning of the period and only cash inflows occur during the rest of the period.

Thus, except for the Initial Cash outflow at the beginning, all the cash flows occur only in one direction i.e., Inwards and are called cash Inflows. The cash out flow is represented by the ( - ) sign, i.e., minus sign and cash Inflows are represented by the ( + ) sign, i.e., plus sign.

Nonconventional Cash Flow stream:

A Nonconventional cash flow stream is a series of cash flows over a given period of time, which is characterised by both inflows and outflows. There is no specific direction to the cash flows. There could be cash inflows for a year or two followed by cash outflows.

Thus, except for the Initial Cash outflow at the beginning, all the other cash flows occur in both directions i.e., Inwards and Outwards.

Based on the above explanation of Nonconventional Cash Flows we can infer that:

Project A : The project A has only outflows and no Inflows, which is a Nonconventional Cash flow stream. Usually Initial cash Outflow is followed by one or more streams of Inflows, which is not the case in the given stream of cash flows, hence nonconventional cash flow.

Project B : Project B has Initial Cash Outflow in Year 0, followed by only cash inflows, thus it can be said that it has a conventional cash flow.

Project C : Project C has Initial Cash Outflow in Year 0, followed by another cash outflow in Year 4, thus it can be said that it has a Nonconventional cash flow.

Project D : Project D has Initial Cash Outflow in Year 0, followed by only cash inflows, thus it can be said that it has a conventional cash flow.

Project E : Project E has Initial Cash Outflow in Year 0, followed by cash outflows in Year 2 and Year 4, thus it can be said that it has a Nonconventional cash flow.

Thus the Solution is Option 3 : Projects A, C & E.

Thus Projects A, C & E exhibit a nonconventional cash flow stream.