I agree with James’ definition and formula of incremental cash flow. However, in my opinion, more information could be given on the structure of the incremental cash flow, such that it consists of three components: initial investments, operating cash flow, and terminal year cash flow. I believe that it is also necessary to highlight how the incremental cash flow can be utilized. Incremental cash flow can be used independently, but it is also required to calculate “net present value (NPV), internal rate of return (IRR), and payback period (PP)” (Investopedia, n.d., para. 3). Such concepts as sunk costs, opportunity costs, cannibalization, and allocated costs are indeed essential to understanding a firm’s financial context. In my opinion, it is also crucial to understand the limitations of the incremental cash flow, such as the fact that various external factors are difficult to predict or project (Investopedia, n.d.). Furthermore, it can be challenging to differentiate between the project’s cash flows and other cash flows of the firm.
The given definition of incremental cash flow is complex and comprehensive. Moreover, I agree that a holistic approach is to be utilized to consider a project. However, some more focus on alternative and additional mechanisms of project evaluation could be considered as paying attention to only incremental cash flow is not enough. Incremental cash flow itself can be considered within more complex evaluation tools, such as NPV, IRR, and PP. Finally, there are also other limitations of incremental cash flow that can be discussed within the given topic. Overall, I agree that the incremental cash flow approach is one of the essential tools to be used; however, it is recommended to use it jointly with other techniques to achieve maximum accuracy.
Reference
Investopedia. (n.d.). Incremental cash flow. Web.