Introduction to Finance

stand-alone principle
ensures that analysts focus on 
the project’s own cash fl ows, uncontaminated by cash fl ows from the fi rm’s other activities. 
We should treat the project as its own mini-fi rm and create fi nancial statements specifi c to the 
project. 
Relevant Project Cash Flows 
A project’s relevant cash fl ows include its incremental 
after-tax cash fl ows, any cannibalization or enhancement eff ects, and opportunity costs.
stand-alone principle 
analysis 
focuses on the project’s own cash 
fl ows, uncontaminated by cash fl ows 
from the fi rm’s other activities

---

17.9 Estimating Project Cash Flows
541
Incremental After-Tax Cash Flows.
The stand-alone principle requires the analyst to 
examine the future after-tax cash fl ows that occur only as a result of the project. These are 
the project’s 
incremental cash fl ows
. The cash fl ows are incremental as they represent the 
diff erence between the fi rm’s after-tax cash fl ows with the project and its 
base case
, or the 
after-tax cash fl ows without the project. To calculate this diff erence, analysts must identify all 
cash fl ows that will rise or fall as a consequence of pursuing the future project. This includes 
any expected changes in revenues, expenses, and depreciation, as well as investments in fi xed 
assets and net working capital.
ETHICAL
Managerial estimates need to be checked and verifi ed as part of the capital budget 
review process. Ethical lapses, such as infl ating revenues and decreasing expenses to make a 
project look more attractive, may result in harm to the fi rm and reductions in shareholder wealth.
Estimating incremental after-tax cash fl ows for a project requires a more thorough analysis 
than does determining the expected change in cash fl ows from the fi rm’s current condition. If 
future strategic moves by competitors are expected to damage or eliminate a fi rm’s competitive 
advantage, the fi rm’s base case cash fl ow forecast should refl ect this situation. A project’s incre-
mental cash fl ows would then refl ect expected changes from this declining trend.
For example, a fi rm such as Intel must consider competitors’ responses when it invests in 
R&D to develop new computer chips. Intel’s base case must include the impact on its sales if 
it does not develop the next generation of computer chips fi rst. In the fast-moving technology 
market, being second to market could mean billions of dollars’ worth of lost sales.
Intel has poured billions of dollars into factory improvement and expansion projects in 
order to increase its production capacity. The goal is to maintain and increase Intel’s com-
petitive advantage over other chip manufacturers and to sustain cash fl ow growth. Greater 
capacity means greater economies of scale, lower costs, and better competitive position in 
the computer chip market. With forecasted chip demand experiencing double-digit growth 
rates each year, Intel needs additional capacity to maintain its current market share of the 
chip market.