Projects often create side costs and benefits that are not captured in the initial estimates of cash flows used to estimate returns. In this chapter, we examined some of these indirect costs and benefits:

• Investing in one project may prevent us from taking alternative investments if these are mutually exclusive. If projects have equal lives and there are no capital rationing constraints, we can pick the investment with the higher net present value. If this is not the case, we have to find ways of controlling for differences in project lives (by computing an equivalent annuity) and for differences in scale (by computing profitability indices).

• Opportunity costs measure the costs of resources that the company already owns that might be used for a new project. While the business might not spend new money acquiring these resources, there are consequences in terms of the cash flows which have to be reflected in the returns.

• Projects may also provide synergistic benefits for other projects that a firm might have. These benefits, which also take the form of cash flows, should be reflected in the returns.

• Projects may also create options that are valuable - options to expand into new markets and to produce new products.

In summary, the project returns have to reflect all of the side costs and benefits.

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

Get My Free Ebook

Post a comment