Capital budgeting decisions should be based on cash flows that are adjusted for the time value of money. The time value of money recognizes that a dollar received or spent In the future Is less valuable than a dollar received or spent in the present. Calculations such as the internal rate of return, net present value, and excess present value include adjustments for the time value of money.
In these calculations resent value factors, financial calculators, or computer software are used to discount the cash flows to their present values. Under accrual accounting, revenues and expenses are reported based on accounting principles. This means that revenues are reported when they are earned, and expenses are matched to the periods of the revenue. In other words, revenues and expenses are not reported on the income statement when the money Is received or spent.
Further, the revenue and expense amounts are not adjusted for the time value f money because of the monetary unit assumption. The cash flow account In which being expressed as gain or loss on sale, Incremental cash flow, depreciation, tax shield, opportunity cost and initial investment, while sunk cost is being ignored due to its nature. However the natures of the project and management decision mechanism – capital rationing are factors to be consider as well. 2. What kind of cash flow should be included in capital budgeting analysis? Incremental cash flows
Incremental cash flows refer to cash flows arising as a consequence of an investment decision. They represent the change in the firm’s cash flows that occurs as a result of accepting a project. Cash Inflows Cash revenue, tax savings, salvage value, fund receipt, change In net working capital Of current assets are greater than current liableness), etc. Cash outflows Initial investment/costs, cash expenses, centralization, change in net working capital (if current assets are less than current liabilities rent revenue foregone, opportunities cost, tax payment, etc.
