WEEK 2 NPV, PBP, IRR, EAC( equivalent annual cash flow)
NPV: If NPV>0, accept the project [which are expected to add value to the firm], otherwise don’t bother.
Reminders
Rule 1: Only cash flow is relevant
Cash flow ≠ accounting income
•In an income statement, profit is shown as it is earned rather than when the company and its customers get around to paying their bills.
•Cash outflows are sorted into two categories: 1) current expenses, deducted when calculating income; and 2) capital expenses, depreciated over several years.
•Always estimate cash flows on an after-tax basis; taxes should be discounted from their actual payment date
Rule2: Estimate cash flows on an incremental basis
Do not confuse average with incremental pay offs: Sometimes throwing good money after bad results in a large pay off.
•Include all incidental effects: PS4 will cause sales of PS3 to decline.
•Forecast sales today and recognize after-sales cash flows to come later: GE’s revenue from both sales of engines and from service and spare parts.
•Include opportunity costs: For example, a new manufacturing operation uses land that could otherwise be sold for$100,000.
•Forget sunk costs: Sunk costs are like spilled milk.
•Remember salvage value: Don’t forget taxes you have to pay on the sales of plants and equipment
Rule3: Treat inflation consistently

PBP: The payback period of a project is the number of years it takes before the cumulative forecasted cash flow equals the initial outlay.
•The payback rule says only accept projects that “payback” in the desired time frame.
•This method is flawed, primarily because it ignores later year cash flows and the present value of future cash flows.

The IRR rule is to accept an investment project if the opportunity cost of capital is less than the IRR.
•Provided that cash flows do not change sign, the NPV and the IRR