Project Management

Step 4: Calculate the Net Cash Flow Using an Agreed-upon
Discount Rate. Because the value of a dollar in the future is less
than the value of a dollar today, the value of future cash flows
must discounted using the formula shown in Figure 4-3. The let-
ter “r” is the discount rate,
cost of capital,or required
return—is, in simple terms,
what the investor (your
company) could expect to
receive from any other
investment that is consis-
tent with its risk tolerance. Ordinarily, the company’s financial
department establishes the discount rate.
By using this formula, you can easily calculate the net present
value of any project. An NPV greater than zero indicates that your
project is expected to provide a financial return that exceeds the

62 Project Management

YEAR after project initiation

Cash Flow/Year

1 2 3 4 5 6 7 8 9 10

Cash Outflows

R&D Costs

Capital Costs

Operating Costs

-40 -20

-80 -60

-40 -40 -40 -40 -40 -40 -40

Cash Inflows

Sales

Maintenance

Materials

Waste

+80

+15

+10

+5

+80

+15

+10

+5

+80

+15

+10

+5

+80

+15

+10

+5

+80

+15

+10

+5

+80

+15

+10

+5

+80

+15

+10

+5

-40 -100 -60 +70 +70 +70 +70 +70 +70 +70

Discounted

Cash Flow/Year -40 -91 -50 +53 +48 +43 +40 +36 +33 +30

Cumulative

Discounted

Cash Flow

-40 -131 -181-128 -80 -37 +3 +39 +72+102

Figure 4-2. Cash flow diagram (all dollars in 000s)

Discounted cash flowA

calculationof the present

valueof a projected cash flow

based on some assumed rate of infla-

tionor interest.