Briefly discuss why financial decision makers must - 4138

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Briefly discuss why financial decision makers must focus on incremental cash flows when evaluating new projects. 

 

As per Principle 3: “Cash—Not Profits—Is King”, and Principle 4: “Incremental 

Cash Flows—It’s only what changes that counts, we should focus on free cash 

flows—that is, the incremental or different after-tax cash flows attributed to the 

investment proposal.   We focus on cash flows rather than accounting profits, 

because these are the flows that the firm receives and can reinvest.  Only by 

examining cash flows are we able to analyze the timing of the benefit or cost 

correctly.  Also, we are only interested in these cash flows on an after-tax basis, as 

only those flows are available to the shareholder.  In addition, it is only the 

incremental cash flows that interest us, because, looking at the project from the 

point of the company as a whole, the incremental cash flows are the marginal 

benefits from the project and, as such, are the increased value to the firm from 

accepting the project.

 
Solution Description

Briefly discuss why financial decision makers must focus on incremental cash flows when evaluating new projects.

 

As per Principle 3: “Cash—Not Profits—Is King”, and Principle 4: “Incremental