Operating cash flow demand (OCFD) is the present value of the minimum amount of cash a capital investment must generate over its life in order to meet the investor’s minimum required return.
How It Works (Example):
Let’s assume that Company XYZ wants to purchase a widget machine. The price is $750,000. The machine is expected to generate $100,000 of cash each year for 10 years. If the present value of the cash flows is $600,000, then Company XYZ should offer no more than $600,000 for the machine. After all, the machine will only generate that much in cash flow for the company.
If Company XYZ is going to pay more, then the machine needs to generate more cash each year or have a longer useful life, or perhaps the company might use a different cost of capital with which to discount the cash flows.
Why It Matters:
OCFD is a strategic tool that helps companies and investors evaluate capital-spending decisions. It gives a clear yes/no decision when evaluating projects. The investment’s cost, useful life, discount rate and efficiency all affect OCFD.
