Net Present Value & Capital Budgeting Chapter 7Net Present Value and Capital Budgeting In this chapter we will describe how to actually do a net present value and discounted cash flows analysis for capital budgeting. The primary aim of this part is to describe how to identify a project’s incremental cash flows. In this part we also discusses how to handle such as sunk costs, opportunity costs, financing costs, net working capital, and erosion. Chapter 7Net Present Value and Capital Budgeting 7.1 Project cash flows: a first look 7.1.1 Relevant cash flows A relevant cash flows for a project is a change in the firm’s overall future cash flow that comes about as a direct consequence of the decision to take that project. The relevant cash flow also called the incremental cash flows associated with the project. Incremental cash flows is the difference between a firm’s future cash flows with a project or without the project. Chapter 7Net Present Value and Capital Budgeting The concept of incremental cash flow is central to our analysis, so we will state a general definition and refer back to it : The incremental cash flows for project evaluation consist of any and all changes in the firm’s future cash flows that are a direct consequence of taking the project. 7.1.2 The stand-alone principle Once we identify the effect of undertaking the proposed project on the firm’s cash flows, we need only focus on the project’s resulting incremental cash flows.this is called the stand—alone principle. The Stand—alone principle refers to the rule that evaluation of a project based on the project’s incremental cash flows.
