The BottomUp Approach

Because we are ignoring any financing expenses, such as interest, in our calculations of project OCF, we can write project net income as:

Project net income = EBIT - Taxes = $200 - 68 = $132

Ross et al.: Fundamentals I IV. Capital Budgeting I 10. Making Capital I I © The McGraw-Hill of Corporate Finance, Sixth Investment Decisions Companies, 2002

Edition, Alternate Edition

332 PART FOUR Capital Budgeting

If we simply add the depreciation to both sides, we arrive at a slightly different and very common expression for OCF:

OCF = Net Income + Depreciation

This is the bottom-up approach. Here, we start with the accountant's bottom line (net income) and add back any noncash deductions such as depreciation. It is crucial to remember that this definition of operating cash flow as net income plus depreciation is correct only if there is no interest expense subtracted in the calculation of net income.

For the shark attractant project, net income was $21,780 and depreciation was $30,000, so the bottom-up calculation is:

This is exactly the same OCF we had previously.

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