1. The “With-and-Without” Estimation Principle
When building an appraisal model, you must only include cash flows that will change directly as a result of accepting the project. This is called Incremental Cash Flow Modeling. You compare the company’s total cash position with the project against its cash position without the project.
2. Advanced Cash Inclusion and Exclusion Rules
Cash Items to Include
- Opportunity Costs: If a project uses an existing corporate warehouse that could otherwise be rented out for $5,000 a month, that lost rent must be recorded as a cash cost of the project.
- Working Capital Injections: New operations often require immediate cash investments to stock up on inventory and fund initial credit sales. This working capital is tied up on Day 1 but is typically recovered and recorded as a cash inflow at the end of the project.
- Cannibalization Effects: If a new product line steals sales from an existing company product, the lost cash returns must be charged against the new project.
Items to Exclude
- Sunk Costs: Money already spent on past research, testing, or feasibility studies must be ignored.
- Financing Costs (Interest Payments): Interest charges and loan fees are left out of cash flow rows because they are already accounted for within the discount rate used to run the model. Including them twice distorts the final NPV.
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