Project Cash Flows | Corporate Finance | CPA Exam BEC | CMA Exam | Chp 10 p 1

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A relevant cash flow for a project is a change in the firm's overall future cash flow that comes about as a direct consequence of the decision to take that project. Because the relevant cash flows are defined in terms of changes in, or increments to, the firm's existing cash flow, they are called the incremental cash flows associated with the project.
The concept of incremental cash flow is central to our analysis, so we will state a general definition and refer back to it as needed:
The incremental cash flows for project evaluation consist of any and all changes in the firm's future cash flows that are a direct consequence of taking the project.
THE STAND-ALONE PRINCIPLE
In practice, it would be cumbersome to actually calculate the future total cash flows to the firm with and without a project, especially for a large firm. Fortunately, it is not really necessary to do so. Once we identify the effect of undertaking the proposed project on the firm's cash flows, we need focus only on the project's resulting incremental cash flows. This is called the stand-alone principle.

What the stand-alone principle says is that once we have determined the incremental cash flows from undertaking a project, we can view that project as a kind of “minifirm” with its own future revenues and costs, its own assets, and, of course, its own cash flows. We will then be primarily interested in comparing the cash flows from this minifirm to the cost of acquiring it. An important consequence of this approach is that we will be evaluating the proposed project purely on its own merits, in isolation from any other activities or projects.