Briefly discuss why financial decision makers must

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.

 

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