WEEK
ONE:
Estimating
Cash
Flows
and
NPVs
ARTICLE
How
to
Use
Net
Present
Value
Analysis

Anet
present
value
analysis
assesses
a
project
that
requires
a
cash
outlet
upfront
to
achieve
lower
costs
going
forward

Avyear
from
now,
a
dollar
will
not
be
worth
as
much
as
a
dollar
today;
there
is
a
cost
associated
with
having
your
cash
tied
up
for
a
year

Cost
of
capital

you
have
to
borrow
money
and
pay
interest,
or
you
may
have
to
forego
other
projects
that
would've
had
a
positive
return

Suppose,
your
cost
of
capital
is
15%.
A
dollar
today
will
be
$1.15
a
year
from
now

To
complete
the
analysis,
we
discount
all
the
positive
cash
flows
we expect
to
happen
in
the
future
to
put
them
in
today's
dollars,
so
the
client
can
compare
the
positive
cash
flows
to
the
negative.

A
good
analysis
alone
rarely
provides
the
answer
to
a
business
problem.
Rather,
it
allows
you
to
identify
the
critical
factors
to
which
the
decision
is
sensitive.
Related:
Consider
These
5
Factors
Before
Making
Your
Next
Big
Decision
Â¢
Production
volume

There
is
an
assumption
about
the
volume
the
new
technology
will
be
required
to
produce
that
will
be
determined
by
your
sales.
How
much
lower
would
sales
have
to
be
to
cause
this
to
be
a
bad
investment
(i.e.,
cause
the
NPV
to
be
negative)?
e
Cost
savings
â€”
The
analysis
assumes
that
your
costs
will
be
reduced,
but
suppose
you
don't
realize
all
of
these
savings?
How
much
lower
would
annual
savings
have
to
be
to
cause
the
NPV
to
become
negative?
e
Price

There
will
be
an
assumption
about
how
much
you
will
get
for
your
product.
What
happens
if
the
price
changes?
Is
this
likely?
e
Time
horizon

The
analysis
will
have
an
end
date
(perhaps
10
years
from
now).
If
new
technology
could
come
along
in
five
years
that
will
make
your
purchase
obsolete,
a
10year
time
horizon
is
too
long.
e
Terminal
value

How
much
is
the
technology
assumed
to
be
worth
at
the
end
of
the
time
horizon?
Perhaps
you
could
sell
it,
but
it
may
be
worth
no
more
than
scrap
value.
In
fact,
you
may
have
to
pay
to
have
it
removed.
Â¢
Discount
rate

Does
the
discount
rate
used
in
the
analysis
reflect
your
true
cost
of
capital?

For
example,
the
sensitivity
analysis
may
show
that
if
unit
sales
grow
at
10%
per
year
or
more,
the
investment
is
a
good
one.
If
sales
grow
less
than
that,
the
new
technology
isn't
a
good
investment.
You
can
then
apply
your
judgment
to
determine
how
much
you
think
sales
will
grow.