101 Concepts for the Level I Exam

**Decisions should be based on incremental cash flows (not on accounting income as it is based on accrual basis):**

- Exclude sunk costs

For example, already incurred costs like preliminary consulting fees should not be included in the analysis.

- Include externalities – Both positive/negative externalities should be considered in the analysis.

For example, negative impact of a new diet soda product launch on the sales of existing soda products.

(Note: In a conventional cash flow, the sign of cash flows changes only once during the life of the project; while an unconventional cash flow has more than one sign change.)

**Timing of cash flows is vital:**Due to time value of money, cash flows received earlier are more valuable than cash flows received later.**Cash flows are based on opportunity cost**

For example, if you plan to use an existing office space rather than renting it out, then rental income from the office space is an opportunity cost.

**Cash flows are analyzed on an after-tax basis:**Shareholder value increases only on the cash that they have earned. Hence, any tax expenses must be deducted from the cash flows.**Financial costs are ignored:**Financial costs are already included in the cost of capital (discount rates) used to discount cash flows to arrive at the present value. Hence, to avoid double-counting, they must not be deducted from the project’s cash flows.