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Cash flows for capital budgeting are estimated to evaluate the viability and profitability of long-term investment projects. These cash flows include all the incremental cash inflows and outflows directly associated with the investment decision. Estimating cash flows accurately is essential as the entire decision-making process depends on the reliability of these estimates. The process generally involves identifying relevant cash flows, discounting them appropriately, and analyzing their impact on the firm’s financial health. In capital budgeting, the primary objective is to include only relevant cash flows, which are incremental in nature. Incremental cash flows refer to the additional cash inflows and outflows that will occur if the project is undertaken, as opposed to the scenario where it is not implemented. These cash flows can be classified into three broad categories: initial investment outlay, operating cash flows, and terminal cash flows. The initial investment outlay includes the purchase price of the asset, installation costs, legal fees, transportation, and other expenses required to bring the asset into a usable condition. This is generally considered as a large cash outflow at the beginning of the project. Operating cash flows refer to the additional revenues and expenses generated during the life of the project. Depreciation is considered for tax purposes, though it is not a cash expense, as it affects taxable income. Finally, terminal cash flows involve salvage value, working capital recovery, and any additional inflows or outflows at the end of the project’s life. While estimating cash flows, certain important considerations are kept in mind. These include ignoring sunk costs, as they ________ ____ ________ ________ _________ ________ __________.
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