Question
In capital budgeting decisions, cash flow is emphasized because cash flow is a spendable resource, while accounting income is not. ROI uses accounting income. ROI
In capital budgeting decisions, cash flow is emphasized because cash flow is a spendable resource, while accounting income is not. ROI uses accounting income. ROI is often used as a screening tool in evaluating capital investment alternatives, where if an alternative is projected not to generate a minimum ROI (after all, the company has to make sure that the investment will positively impact its accounting earnings per share), that alternative is screened out immediately. Another screening tool often used is payback period, which is also based on cash flow (undiscounted) and which measures how long it will take before you get back your initial investment amount from projected cash flows. Once alternatives survive these initial screening tests (ROI and payback period), they are then evaluated by using the more demanding tools of NPV and internal rate of return, both of which are based on cash flow.
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