Consistency Principle

Consistency Principle is one of the four major principles that are used for estimating the project cash flows. According to this principle, consistency in the cash flows is very necessary. At the same time, consistency in the applicable discount rates on the cash flows should also be maintained.
There are two important factors that are related to the Consistency Principle. These two are the investor group and the inflation.Investor Group: The Consistency Principle holds that while estimating the project cash flow, it is also important to consider the investor’s opinion or view. There are different types of investors in a firm like the lenders or the stockholders and so on.Again, if it is not possible to consider every kind of investors’ view, then the stockholder’s view regarding the cash flow may be considered.
According to the investor’s standpoint, the project cash flow denotes that amount of cash that is provided to the investors. The payable taxes must be deducted from this amount and if there is any need for investment in the ongoing project then that amount should also be deducted from the amount allotted for the investors.
At the same time, if the stockholders standpoint is regarded then the project cash flow is that amount that is offered to the stockholders. This amount should not include any kind of payable tax or any such amount that is necessary to invest in the particular project. Again, before offering any money to the stockholders, the firm is required to clear all the debts.

Now, the next important factor is the consistency of the discount rate that is to be applied on the project cash flow. There are two types of discount rate known as the weighted average cost of capital and cost of equity.

Inflation: In case of inflation, there are two ways of estimating the project cash flow of a particular project. The first option is to merge a likely inflation in the project cash flow estimates. After this, a nominal discount rate is applied on the amount. Another way of handling the inflation factor is to calculate the project cash flows of the future in real terms with real discount rates.

 

 

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Last Updated on : 27th June 2013

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