Relevant Cash Flows — OpenTuition Forums

Jjenny8y ago

Hi John, Firstly, apologies, I wanted to say thank you for the previous question you answered, but it was already locked. Would you be able to help me once more understanding the following question/answer, please? Which of the following are categories of relevant cash flows? I Annual net cash flows II Project termination cash flows. III Incremental cash flows. IV Net initial investment. Select one: a. I, II and III b. I,II,III and IV c. I and II only d. I,II and IV The correct answer is d (all, but incremental) My understanding regarding relevant cash flows is the following: “The relevant cash flows for appraisal of a project are the changes in future cash flows that would arise from acceptance of the project.” (incl. future cost, cash flows, incremental cost) And according to your F9 Notes provided it is: “The general rule is that we are interested in all future, incremental (or extra), cash flows to the company as a result of undertaking the investment.” So I really don’t understand why, in the question above, all answers are correct, except for incremental. ? Thank you so much for all your help. Jenny

John MoffatTutor8y ago#1

I don't know where you found this question (I hope it wasn't a past exam question!!) but it really is stupid if you have copied it correctly (or else the book has made a mistake!). Incremental cash flows certainly are relevant!!!

Jjenny8y ago#2

Thank you so much for your help! The explanation is: "An incremental cash flow is the difference in cash received or disbursed resulting from selecting one option instead of another. It is not a category of relevant cash flows." "Relevant cash flows are a much more reliable guide when judging capital projects, since only they provide a true measure of a project’s potential to affect shareholder value. The relevant cash flows can be divided into three categories: (1) net initial investment, (2) annual net cash flows, and (3) project termination cash flows." Can I completely ignore this and just remember that incremental cash flows are all given opitions?

John MoffatTutor8y ago#3

Ignore it - incremental cash flows are relevant cash flows! If doing the project involves extra (incremental) costs that are not incurred if we do not do the project, then those incremental costs are relevant cash flows.

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