Alternative Definitions Of Operating Cash Flow

The analysis we went through in the previous section is quite general and can be adapted to just about any capital investment problem. In the next section, we illustrate some particularly useful variations. Before we do so, we need to discuss the fact that there are different definitions of project operating cash flow that are commonly used, both in practice and in finance texts.

As we will see, the different approaches to operating cash flow that exist all measure the same thing. If they are used correctly, they all produce the same answer, and one is not necessarily any better or more useful than another. Unfortunately, the fact that alternative definitions are used does sometimes lead to confusion. For this reason, we examine several of these variations next to see how they are related.

In the discussion that follows, keep in mind that when we speak of cash flow, we literally mean dollars in less dollars out. This is all we are concerned with. Different definitions of operating cash flow simply amount to different ways of manipulating basic information about sales, costs, depreciation, and taxes to get at cash flow.

For a particular project and year under consideration, suppose we have the following estimates:

With these estimates, notice that EBIT is:

EBIT = Sales - Costs - Depreciation = $1,500 - 700 - 600 = $200

Once again, we assume that no interest is paid, so the tax bill is:

where T, the corporate tax rate, is 34 percent.

When we put all of this together, we see that project operating cash flow, OCF, is:

OCF = EBIT + Depreciation - Taxes = $200 + 600 - 68 = $732

It turns out there are some other ways to determine OCF that could be (and are) used. We consider these next.

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