Incremental cash flow is additional revenue that is generated when a business or other type of organization launches a new project. Cash flow of this type is considered to be outside the standard and usual sources of cash that the organization enjoys, and remains in that class or status until the project is fully integrated into the normal operations of the entity. One of the benefits of identifying incremental cash flow is that it makes the task of measuring the progress, or lack of it, associated with the new project. This in turn aids in evaluating the value of the project to the organization, making it easier to determine if the project should continue or be abandoned.
In identifying the true contribution of the incremental cash flow, several factors must be considered. First, the costs of launching and continuing to operate the project are weighed against any income that the project generates. Assuming that the initial return is greater than the costs of launching and operating the project, a state of positive incremental cash flow exists. This is the ultimate goal for the business, since it serves as a strong indicator that the project is a viable source of revenue and has the potential to be integrated into the basic operations of the company.
The cash flow statement should not include interest expense or dividends. The return required by the investors furnishing the capital is accounted for in the 12 percent cost of capital (WACC) used to discount the cash flows, therefore including interest expense and also discounting would be "double counting." Put another way, if we both subtracted interest (and dividends) and also discounted at the cost of capital, we would in effect be deducting capital costs twice.
The $150,000 test marketing cost is a sunk cost, not an incremental cash flow, so it should not be included in the analysis. Accepting or rejecting the project will have no impact on that cash flow.
If the plant space could be leased to another...