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Using the incremental cash flows and discounting them to reflect the time value of money is the preferred method. The two most common techniques involved in discounting cash flows are net present value and internal rate of return.While the discounted cash flow models are the ideal, I would also want to forecast or project the impact on the company's future financial statements. Therefore, I would also calculate and understand the effect on the accounting profits resulting from the capital expenditure.
A 'Brainstorming' Question indeed! Thanks.
I fully endorse your Wonderful/Constructive submission Mr. SHAHZAD Yaqoob.
Yes, It must be as cashflows will decide the fate of cashflow activities in terms of inflows and outflows. It is likely to be linked with outflows funds particulary on investing activities that is related to capital expenditures. The idea of considering accouting profits during the decision cannot be overlooked as profit lead decision making e.g futher investment in new projects and upgrading of existing units or etc etc.
It should focus on cash flows first to avoid any liquidty problems may suffering the working proceedurs.
Then it foucus on accounting profits to mesure the effect of the capital expenditure decision to the profit.
Profits will only be effected by depreciation that is non cash expenditure, however cash flow will be effected by full purchase consideration, so cash flow is more important.
Generally speaking both are equally important. Company should focus on cash flow for payment of the capital expenditure. However, long term profitability should be also taken into consideration while making the decision.
