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The company’s current fixed costs are $160 million per annum which will increase to $300 million if the new plant is established.Įstimate the annual incremental cash flows of the project. Variable costs are $30 per ton in South Asia and $25 per ton in Africa.

A ton of cement yields $100 ton in international market and $70 in the domestic market. The production not exported shall be sold in the domestic market. However, it will result in reduction in export sales from its home country by 40%. The new plant will cater to the demand Africa and Middle East. The company is interested in setting up a new plant in an African country with a capacity of 5 million tons per annum. is a cement manufacturer with production facility in a South Asian country, which produces 10 million tons per annum, half of which is exported to Africa and Middle East. Non-discounting models, such as payback period, compare the face value of incremental cash flows with initial investment.Įstimating the incremental cash flows of a project is the first and arguably the most important step in the capital budgeting process. If the present value of the future cash flows exceeds the investment required, the project is accepted, otherwise rejected. In some cases, acceptance of a new project may result in reduction in cash flows of another, a phenomenon called cannibalization.ĭiscounting models of capital budgeting such as net present value and internal rate of return, compare the present value of future incremental cash flows and terminal cash flow with the initial investment outlay. In making such estimation, it is important to consider the effect of acceptance of one project on the cash flows of another.

Incremental cash flows are estimated by comparing the company’s net cash flows if the project is accepted and its cash flows if the project is not accepted. Capital budgeting decisions are based on comparison of a project’s initial investment outlay to the future incremental cash flows of the project and its terminal cash flow. Incremental cash flows are the net additional cash flows generated by a company by undertaking a project.