To ascertain a projects incremental cash flow, it is required to check the cash flows of firm with the project and

without the project . The difference between the two reflects the incremental cash flows attributable with the project ie. Project cash flow for the year t=(cash flow for the firm with project for year t)-(cash flow for the firm without the project for the year t)

In estimating the incremental cash flows,the following points must be borne in mind: All incidental effects Ignore sunk costs Include opportunity costs Allocation of overhead costs Estimate working capital properly

In addition to the direct cash flows of project, all its incidental effects must be considered. It may: Enhance complementary activities of the firm.

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Detract from profitability of some of the existing activities of firm for competitive relationship.
Another effect may be effect of product cannibalisation:The erosion in sales of firms existing products on account of new product introduction.This may lead to negative incremental effect of new product as profitability decreases.If the firm is operating in an extremely competitive business and is not protected by entry barriers product cannibalization will occur anyway.

A sunk cost refers to an outlay already incurred in the past. So it is not affected by acceptance or rejection of the project under consideration. Sunk costs are thus ignored as it cannot be recovered irrespective of whether the project is accepted or not and hence are not relevant for decision making

The opportunity cost of a resource is the benefit that can be derived from it by putting it to its best alternative use. For most resources there will be its alternative use:
The resource may be rented out. The opportunity cost is the rental revenue foregone by undertaking the project. The resource may be sold. Opportunity cost is the value realized from the sale of the resource after paying the taxes. The resource may be required elsewhere in the firm. In this case the cost of replacing the resource represents it oppurtunity costs

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Costs indirectly related to product/service

General administrative expense Managerial salaries Legal expenses Allocated on basis like labor hours, machine hours or prime costs When a new project is proposed, a portion of overhed costs is usually allocated to it. For purpose of investment analysis, what matters is the incremental costs attributed to it and not the allocated overhead costs

Working capital = [curent assets,loans,advances]-[current liabilities and provisions]

Current liabilities and provisions are deducted from current assets because they represent non investor claims. Another important point is that the requirement of working capital is likely to change over time.

While fixed asset investment are made during the early years of project and depreciated over time,working capital is renewed periodically, hence is not subject to depreciation.

The cash flow stream relating to long term funds consists of three components as follows:
1. Initial investment Long term funds invested in the project: Fixed assets + working capital margin 2. Operating cash flow Profit after tax + Depreciation + other non cash charges + interest on long terrm borrowings(1-tax rate)

3. Terminal cash flow Net salvage value of fixed assets + net recovery of working capital margin
Net cash flow will be calculated as summation of above 3 components