Important Questions and Answers: Cash Flow

Cash Flow

21. What is revenue dominated cash flow?

The profit/revenue, salvage value of all inflows to an organization will be assigned with positive sign and the cost outflows will be assigned with negative sign is called revenue dominated cash flow.

22. What is cost of dominated cash flow?

ü The cost outflow will be assigned with positive sign and profit, revenue salvage value all inflows etc,.

ü Will be assigned with negative sign is called cost dominated cash flow.

23. Mention the various rate of return method.

ü Internal rate of return(IRR)

ü Average rate of return(ARR)

ü Net present value method (NPV)

ü Pay-back period (PBP)

24. What is rate of return?

Rate of return is the break-even interest rate, I, which equates the present worth of a project’s cash outflows to the present worth its cash inflow

25. What is present worth method?

ü The present worth measures the surplus in an investments project at time zero (0).

ü The present worth of all cash inflows is computed the present worth of all cash outflows associated with an investment of project is called present worth method.

Introduction

In this method of comparison, the cash flows of each alternative will be reduced to time zero by assuming an interest rate i. Then, depending on the type of decision, the best alternative will be selected by comparing the present worth amounts of the alternatives.

The sign of various amounts at different points in time in a cash flow diagram is to be decided based on the type of the decision problem.

In a cost dominated cash flow diagram, the costs (outflows) will be assigned with positive sign and the profit, revenue, salvage value (all inflows), etc. will be assigned with negative sign.

In a revenue/profit-dominated cash flow diagram, the profit, revenue, salvage value (all inflows to an organization) will be assigned with positive sign. The costs (outflows) will be assigned with negative sign.

In case the decision is to select the alternative with the minimum cost, then the alternative with the least present worth amount will be selected. On the other hand, if the decision is to select the alternative with the maximum profit, then the alternative with the maximum present worth will be selected.

BASES FOR COMPARISON OF ALTERNATIVES

In most of the practical decision environments, executives will be forced to select the best alternative from a set of competing alternatives.

Let us assume that an organization has a huge sum of money for potential investment and there are three different projects whose initial outlay and annual revenues during their lives are known. The executive has to select the best alternative among these three competing projects.

There are several bases for comparing the worthiness of the projects. These bases are:

1.   Present worth method

2.   Future worth method

3.   Annual equivalent method

4.   Rate of return method