Introduction to Finance

Cash Flow from Investment Activities 
Cash fl ow from investment activities 
will record the fi rm’s period-by-period fi xed-asset investments in the capital project; namely, 
the plant and equipment necessary to pursue the project. Cash fl ow from investments is usu-
ally negative at the beginning of a project as the fi rm spends cash to acquire, build, modify, 
or replace assets. The cash fl ow from investments may be positive at the end of a project if it 
sells assets for salvage value.
Cash Flow from Financing Activities 
Capital budgeting analysis excludes cash 
fl ows from fi nancing activities. As discussed earlier, relevant after-tax fi nancing costs are in-
corporated into the discount rate used to discount estimated cash fl ows to the present.
An Example 
Now let’s look at an example. Suppose you are considering opening a cam-
pus ice cream shop. Your initial investment in depreciating assets will be $10,000, and your 
initial investment in net working capital (which will include such inventory items as cones, ice 
cream, and toppings) will be $3,500. You forecast no future changes in net working capital. 
You will depreciate fi xed assets on a straight-line basis over four years.
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The shop’s forecasted net income is $0, $1,500, $2,500, and $4,000 over each of the next 
four years. At the end of four years, you expect to graduate with a bachelor’s degree and some 
entrepreneurial work experience, and you will sell your enterprise to another student. You 
hope you can sell your business for $12,000. For simplicity, ignore any tax implications from 
the sale. What are the cash fl ows from this project?
It is sometimes easier to estimate cash fl ows if you construct a table, or use a spreadsheet, 
such as the one shown below. It summarizes the project’s incremental after-tax cash fl ows by 
year and by cash fl ow category. For example, at the current time (year zero), the only expected 
cash fl ows are a $10,000 investment in fi xed assets and a $3,500 outfl ow for net working 
capital. Depreciating the $10,000 in fi xed assets on a straight-line basis over four years gives 
a yearly depreciation expense of $10,000/4, or $2,500.
Year one net income is expected to be $0; along with the $2,500 depreciation expense and 
no change in net working capital, year one’s operating cash fl ow is estimated at $2,500. Since 
you anticipate no investing cash fl ows, year one’s total cash fl ow is estimated to be $2,500.
The cash fl ows for years two, three, and four are computed similarly. In year four, the 
operating cash fl ows are supplemented by an investing cash fl ow of $12,000 from the sale of 
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As noted in the prior paragraph, a capital budgeting project’s balance sheet will typically have a zero cash balance 
as all cash infl ows are claimed by the fi rm and all cash outfl ows are paid by the fi rm.
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Current income tax laws specify allowable methods for depreciating business assets. Accelerated depreciation 
methods are popular but they add unnecessary complexity to the discussion. Straight-line depreciation is a permitted 
method, so we assume it in most of our discussions.

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17.9 Estimating Project Cash Flows
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the business. Thus, year four’s total cash fl ows equal $18,500: $4,000 from net income, $2,500 
from depreciation, and $12,000 from the sale of the business.