 During cash flows projection, in a capital budgeting process, a financial analyst may face certain issues. An important issue is related to the depreciation. Depreciation issues can be further classified into three other issues. First is the policy. This means that whether an asset is to be depreciated in the year of purchase and nor in the year of sale or vice versa. The second is the method. By depreciation method, we mean straight line depreciation method, return down value depreciation method, sum of years depreciation method, unit of output and many others. And other issue in terms of depreciation is the conventions. This means that either the company is going to use half year convention where a half year depreciation is used irrespective of the induction period of the asset or full year convention where the asset might have been inducted for only a portion of the full year. Next depreciation methods are different from accounting point of view and from tax point of view. And there may not be necessarily an agreement between these two options in terms of policy, in terms of convention and in terms of methods. So we can say depreciation issues like policy, methods and conventions may vary for accounting point of view and tax point of view. So far as depreciation in capital budgeting is concerned, depreciation plays a significant role in determining financial worth of the project. In such a way that return down value method when used, it generally improves net present value and the IRR on the project than the usage of straight line depreciation method. Because depreciation has a direct effect upon a tax has a direct effect upon the depreciation. In this way, the tax adjusted depreciation when results in tax savings, it enhances the net present value of the project and the related IRR. On the screen, you can see a comparison of tax savings through the change of depreciation method. We have certain data like a cost of 200,000 rupees and residual value of 25,000 rupees, economic value five years, tax rate of 40% and cost of capital of 10%, whereas the depreciation rate under return down value method has been computed at 22.28%. If at the bottom side, we see the last columns totals, which is the tax saving. We see that tax savings in the straight line method are 53,071 whereas the tax savings in the return down value method in the lower half at right side is 53,373. This comparison is confirming that return down value method ensures more tax savings for a capital project than the straight line depreciation method. Project replacement is an event where an existing project, an existing asset is replaced with a newer one. In this regard, we have some differential cash inflows or differential cash outflows. These differential cash outflows are also termed as incremental cash flows. These incremental cash flows are easily to compute as a difference and how it is computed, let's see. When we need to determine incremental initial cash outflows, we just deduct the solvage value as a tax adjusted solvage value on the disposal of an existing asset from the initial cash investment of the new asset, the resulting cash flow is termed as incremental cash inflow, incremental cash outflow. Now how to determine incremental operating cash flows? We have two projects. The first is the existing project which has its own existing operating cash flows in terms of sales, in terms of operating cash expenses, in terms of depreciation, in terms of tax rates and on the other hand we have projected cash operating cash flows related to the newer project. Now in order to determine incremental operating cash inflows, we need to determine operating cash flows of existing project from the operating cash flows of the newer project. The differential cash flows will be termed as incremental cash inflows, like we need to determine sales from newer project, we need to determine existing sales from the newer sales, so the incremental sales will be there. We need to determine existing operating cash flows from the newer operating cash flows, operating cash expenses, so the incremental operating cash expenses will be there. We need to determine existing tax adjusted depreciation from the newer tax adjusted depreciation. When we add incremental sales, when we deduct incremental cash operating expenses from the incremental cash sales and we add incremental tax adjusted depreciation to this figure, the resulting figure is termed as incremental operating cash inflows. And the third cash flow related to the replacement project is the incremental terminal cash cash flows, these are the non-operating cash flows. How can we determine these cash flows? We need to have a solvage value of the disposal of the project's assets at the end of the life, then we have recovery of the investment in networking capital items. Now when we add these two cash flows, we deduct tax adjusted gain on the disposal of the newer assets from these total cash flows, so the resulting cash flows are known as incremental terminal non-operating cash inflows. The last issue in this regard is the inflation, which is a phenomenon of persisting rise in the general price level. We know that we have nominal cash cash flows, this means that these cash flows carry the effect of inflation they are in. We may have real cash flows, by real cash flows we mean that these are the cash flows that are pre from the effect of inflation or in other words these are the inflation adjusted cash flows. Same question rises, why inflation is significant in capital budgeting? A financial analyst in the process of capital budgeting can use both nominal cash flows or the real cash flows, but he has to be careful while discounting these cash flows. If he is using nominal cash flows, then he has to use a nominal rate of discount. If he is using real cash flows, then the discount rate that is used to determine present value of these cash flows should be free from the effect of inflation.