Financial Accounting: NPV Analysis

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A net present value calculation is based on the principle that future cash flows are not worth as much as present day cash flows, because inflation devalues those future flows (Investopedia, 2012). This implies that there are a number of factors that influence the NPV analysis. For a given project say a hypothetical new factory many different factors will need to be taken into consideration. One such factor is economies of scale. In general, economies of scale will improve the net present value of a project. The reason for this is that economies of scale improve the margins that the company receives on its projects. Improved margins will ultimately translate to increased free cash flow as the result of undertaking the project (MIT, n.d.). Product differentiation does not have a direct impact on the cash flow. Only if product differentiation translates into higher sales would this be something to be factored into the analysis. Cost advantages are the same. A cost saving would be a direct incremental cash flow to be included (no author, 2012), but a cost advantage is something relative to the competition that would need to be translated into the increase in sales in order to become a cash flow. The inclusion of items in an NPV calculation needs to be based on cash flows, not on the underlying factors that may or may not have a specific impact on the cash flows. Thus, access to distribution channels is also not a cash flow. A change in this access may contribute to a

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