一、Relevant cash flow

Investment decisions, like all other decisions, should be analysed in terms of cash flows that can be directly attributable to them.
Relevant cash flow: Future cash flow arising as a direct result of the decision.
 

Sunk Costs
A sunk cost has already been incurred and therefore will not be relevant. Eg. Market research expenditure already incurred.
Opportunity cost
The benefit foregone by choosing one alternative in preference to the next best alternative. Opportunity costs are relevant, and should be included.
 

Fixed cost
Fixed cost arise the all over the organization, the allocated/apportioned cost from existing fixed overhead is irrelevant to decision making, as they will be incurred whether the decision is made or not. Incremental fixed cost will incurred as a result of a decision, it is relevant.

Depreciation
Depreciation is not a cash flow, and so should never be included in a discounted cash flow calculation. The only investment appraisal technique that will include depreciation is ARR.
 

Incremental cost
Only the costs （and revenues） that change as a result of the investment are relevant and need to be included in the appraisal. If a cost or revenue will be incurred without the investment, it should not be included in the appraisal.

Interest costs
Ignore all financing cash flows （e.g. interest charges, loan repayments, dividends, etc.） and all their tax effects （e.g. interest tax relief）. This is because these are all implicitly taken into account through the discounting process.

二、 Working capital

The treatment of working capital is as follows:
It is treated as an investment at the start of the project, like any other investment.
At the end of the project the working capital is 'released'. This is treated as a cash inflow at the end of the project, equal to the total investment in working capital. （unless told otherwise）.
Any additional working capital requirements are invested when required and only the change in working capital is treated as a cash flow.


三、 Implication of inflation

Inflation is a feature of all economies, and it must be considered in financial planning.
With inflation, the purchasing power of money depreciates. The currency will buy fewer goods and services than previously and consequently the real returns on investment will fall. Investors will expect to be compensated for the fall in the value of money during inflation.
Nominal cash flows: the cash flows including inflation
Real cash flows: the cash flows in current prices which does not include inflation
The nominal interest rate incorporates inflation.
The real interest rate does not include inflation.
The relationship between real and nominal rates of interest are is given by the Fisher formula:
（1＋i）=（1＋r）（1＋h）


四、Taxation

Taxation is a major practical consideration for businesses. It is vital to take it into account in making decisions.
Additional profits or net trading revenue leads to an increase in tax paid – a cash outflow.
Tax payments are normally delayed （one year in arrears）.
Tax-allowable depreciation （capital allowance） :
Investment in fixed assets attracts tax relief against taxable profits, and the generate a reduction in tax payment– a cash inflow.

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