Incremental Cash Flow
In capital budgeting, incremental cash flow is the net after-tax cash flow which a project generates over its life. It is also called operating cash flow and it equals the excess of cash inflows over cash outflows on account of operating expenditure and taxes.
Capital budgeting decisions require projecting cash flows into future and then using time value of money techniques to identify whether the project is profitable or not.
Incremental cash flow can be worked out using the following formula:
Incremental Cash Flow = (CIn - COut − D) × (1 − t) + D
Where CIn is the cash inflow, COut is the cash outflows, D is the depreciation expense and t is the tax rate.
Cricket South Asia is appraising construction of the world's largest cricket stadium in Delhi. The project requires initial investment of INR 1,200 million. It is expected to host 150,000 people and generate annual cash inflows of INR 250 million each year for 10 years. Maintenance expenditure is expected to be INR 100 million. For tax purposes, INR 900 million of the stadium value is allowable as a deduction on account of depreciation on straight line basis. Applicable tax rate is 20%.
Find the incremental cash flow of the project over the useful life of the stadium.
Incremental Cash flows = Cash Inflows − Cash Outflows − (Inflows − Outflows − Depreciation) × Tax Rate
Depreciation Expense = INR 900 million/10 = INR 90 million
Taxes per Year = (INR 250 million − INR 100 million − INR 90 million) × 20% = INR 12 million
Incremental Cash Flow = INR 250 million − INR 100 million − INR 12 million = INR 138 million
Written by Obaidullah Jan, ACA, CFA and last revised on