Question

Explain all in detail and support your argument using the financial concepts that are consistent with the book.

1. Explain what is meant by the incremental cash flow and tell me why the incremental cash flow is only relevant for the capital budgeting analysis.

Answer 1

Incremental cash flow is the additional cashflow that is going to occur by taking up a project or making a new investment. The incremental cash flow is equal to the cash flow for the firm if the project is taken up minus the cash flow for the firm if the project is not taken up. Let’s take for example a company has an existing project going on and if the company makes another 100,000 investment then the cash inflow to the project would increase by the 30000 per year, here the incremental cashflow would be the outflow of 100000 and inflow of 30000 per year. The incremental cash flow is the cashflow that is important because the existing project would not be affected by it and that would not affect the financial viability and if the total cash flow is used then the outcome of the evaluation would not be reliable.