Friday Dispute

So some of the executives are kicking around a monumental investment for the firm and there is a dispute on how to evaluate the project. I get called into the CFO’s office with some of the other BSDs of the firm and get asked to settle their argument as I am the CFA & MBA & Etc. Oracle of the team.

“So CvM, we are looking at launching this initiative which will have a 5 year ramp of cash outflows before we see any cash inflow. We (CFO and CEO) have a disagreement on the correct way to account for these initial costs. Is year ‘zero’ the first year we spend money on said project, or is year ‘zero’ the first year we have cash inflows on said project with all cash outflows up to that point summed?”

I said you’d need to look at the first year you spend incremental CAPEX on said project while ignoring sunk costs up to that point. They said, great, but get us evidence as we have a wager on this.

So my bruthas, I now ask you to help settle this dispute once and for all. Google will give me either answer based on hacksaw finance book authors, but what is the ‘right’ way?

The way I see it, if you’re doing a net PRESENT value calculation, then year zero would be the PRESENT year.

Can we turn this into a “It’s Friday People…” thread? I miss those.

You’re a CFA, MBA & FRM and you can’t do a simple NPV?

^ Guess so. Neither can the CFO and CEO. You’re right, we’re all failures and deserve to be stripped of our charters and castrated into an eunuch by ISIS. May our BSDs RIP.

If you had any sort of reading comprehension, the dispute is the sum of all cash out flow years in year zero or the first year of cash outflows as year zero.

No love for CAIA?

No NPVs in CAIA, just tons of terms and how to value a convertible bond, whooptie doo.

Seems like you should put the net outflow in the year where you actual pay that money, not the year when cash flow comes in (what if cash flow never comes in?). Maybe offset the expenditure with some new asset on the balance sheet, or say it is some “extraordinary” outflow.

Although, what do I know.

So you’re asking if a $100 outflow in 2015, a $100 outflow in 2016, a $100 outflow in 2017, and a $100 outflow in 2018 all have the same NPV?

You believe (in your NPV calc) that all of these add up to a $400 cash outflow in 2015? Or a $400 cash outflow in 2018?

It’s neither – you’d have a $100 ouflow for the present (undiscounted) outflow and the other outflows (and future inflows) would all be discounted back to present.

^That’s my point.

If you believe that all cash outflows have the same NPV, then propose this to your bosses–they shall send to the Greenman, on Jan. 1, $10m per year for the next ten years. At the end of the ten years period, I will promptly return to them their $100m, with no interest. Because the cash flows have no time value, neither of us should have made any money, and the return of their capital makes them whole.

This is my thought.

For some reason one of the Execs thought you could simply add up the outflows from 15,16,17 and use that amount as a year zero. It’s semantics as the project is very profital both ways, but the payback period is different based on each method.

Anyways, my hangover is getting worse recanting all of this ish from L1 and B School.

TBH, I really have a hard time believing that this is a real question. The answer is so obvious, a L1 candidate with a hacksaw BBA should be able to answer it.

^ Stranger things have happened man. Realize that it’s likely both know the ‘right’ way to analyze this, but each of them have personal incentives (CEO, bigger organization/CFO, more cash on hand) representing the principal agent problem. Rationalization is a real and sneaky thing.

The current year is year zero. All outflows are discounted from when they begin to the current period as are inflows. You could calculate NPV at period X if X is when outflows begin, but that would be NPV at that period, you’d have to discount that back to the current period to have true NPV. Discounting the NPV back would have the same end result.

How does nobody know this. Do you work at a local MacDonalds branch?

^So you’re saying a NET PRESENT VALUE calculation calculates the VALUE at the PRESENT, NET of all cash flows?

Whodathunkit?

You’ve been an angry poster lately. What’s going on man? Is something causing you distress and grief? Got some tension you need to let go of? Relax bro. Try some yoga.

I got the world on my shoulders cvm. If yoga is a code word for some sort of heroin vacation you may be on to something.

.

^ Prayers bud. Now I feel like a d!ck griping about which way to calc a payback period.