Checklist for calculating NPV

When calculating NPV be aware of the following possible mistakes:

1. Discount cash flows, not profits:
   1. Remember that depreciation is not a cash flow
   2. Concentrate on cash flows after taxes. Stay alert for differences between tax depreciation and depreciation used in reports to stakeholders.
   3. Exclude dept interest or the cost of repaying a loan from the project cash flows. This enables you to separate the investment fro the finance decision.
   4. Remember the investment in Working Capital. As sales increase, the firm may need to make additional investments in Working Capital. As the project comes to an end, it will recover those investments.
   5. Beware of allocated overhead charges (heat, light, etc). these may not reflect the incremental cost of the project.
2. Estimate the projects incremental cash flows - that is, the difference between the cash flows with the project and those without the project.
   1. Include all indirect effects of the project, such as the impact on the sales of the firm's other projects.
   2. Do not forget Working Capital requirements
   3. Forget Sunk costs
   4. Include Opportunity Costs, such as the value of land that you would otherwise sell.
3. Treat inflation consistently
   1. If cash flows are foretasted in nominal terms, use a nominal discount rate
   2. Discount real cash flows at a real rate.