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Hi Sir
Sorry – I feel very overwhelmed and cannot make sense of this…
1. If we’re asked to appraise a project (like a special contract) would we identify ALL of the benefits pertaining to that project (observable, measurable, quantifiable and financial) and ensure that we specify which elements aren’t financial or do we use marginal analysis rules and only include future incremental differential cash flows?
2. On a related note, I can’t properly recall my earlier studies – when we are using longer-term appraisal techniques (say, for an investment) – do we use relevant cash flows only (future incremental differential cash flows only)?
3. For example, if Walmart were to open up a coffee kiosk, near it’s ATM machines, and this was set to generate $5m of coffee revenue, but it would cause a fall in its revenue from its in-store cafes, of $2m, would the future incremental differential cash flow, be $3m only, in that investment appraisal, because: although, there’s a specific incremental cash flow of $5m generated, the differential is $3m only, due to the $2m fall of in-store coffee sales, this creates?
4. Lastly, if an investment appraisal, such as an NPV appraisal, has been prepared and we’re asked to evaluate the appraisal, and we find that this includes an interest charge, as a cash outflow – is that incorrect because the cost of capital already includes that interest charge (together with a premium for risk and tax)? Further, should we re-compute the NPV removing the effects of that interest charge outflow, to see if the decision changes?
Thank you,
Ali
1 The problem with observable and measurable is that it will be impossible to put a figure kn them. These need to be taken into account in a more subjective way. Eg is the NPV were negative it might be worth saying that there could be important factors, impossible to quantify and that these might be enough ti ‘tip the balance’ to project acceptance.
2 Yes. Thea is the key to NPV.
3 Correct.
4 Yes. NPV calculations should include neither interest charges nor repayment of the loan principal.
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