What are Conventional and Non-Conventional Investment Projects?

Banking & FinanceFinance ManagementGrowth & Empowerment

The terms "conventional projects" and "non-conventional projects" are derived from conventional and non-conventional cash flows. Therefore, it is necessary that we understand the difference between conventional cash flows and non-conventional cash flows.

Conventional Cash Flows

Conventional cash flow is a series of cash flows that go in one direction over time. If the initial flow is an outflow, then the next flows will be followed by successive periods of cash inflows.

This type of inflows can also occur so that if the preliminary transaction is a cash inflow, it will be followed by a series of cash outflows. Accordingly, the mathematical notation would show the transaction as −, +, +, +, +, +, which denotes an initial outflow at the time period 0, and continued cash inflows over the next five periods.

So, we would regard an investment project as "conventional" if it has only one change in the sign of cash flow; it can be minus to plus or vice versa.

Conventional cash flow is widely used in the net present value (NPV) analysis. NPV is a way to determine the value of a series of future cash flows in present value and compare the obtained values to the return of an alternative investment. The return from conventional cash flows of a project over time, for example, should exceed the company’s minimum rate of return if it needs to be profitable.

Conventional cash flow is also applied in "discounted cash flow (DCF) analysis." With DCF analysis, the investor uses either Internal Rate of Return (IRR) or Net Present Value (NPV) to evaluate the potential income that a particular investment project can generate. NPV and IRR can both be used to examine independent or dependent projects.

Unconventional Cash Flow

Unconventional cash flows don’t go in only one direction. It is represented by not just one, but many changes in the direction of the cash flow. These changes in direction are usually represented by the positive (+) and negative (–) signs. The positive sign (+) means a cash inflow, while the negative (–) sign denotes a cash outflow.

An unconventional cash flow could appear as (−, +, +, +, -, +) or alternatively, (+, −, −, +, −, −). This will indicate that the first set has a net inflow, and the second set has a net outflow of cash. If the first set represents cash flows in the first quarter and the second set represents cash flows in the second quarter, this would indicate an unconventional cash flow for the company.

Cash flows are used to determine the net present value (NPV) in a discounted cash flow (DCF) analysis in capital budgeting. This analysis is used to help determine whether the initial cost of investment of a project will be worthwhile in comparison to the NPV of the future cash flows generated from the project.

raja
Published on 28-Oct-2021 12:01:13
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