Can someone please explain when is the appropriate use of CF0 = 0 vs when CF0 is an negative outflow cost?
For example, for some cash flow calculations, I’ve seen CF0 should equal 0 and some NPV calculations have CF0 = initial investment cost (negative number). I am confused as to when to use either/or?
Thanks!
CF0 is only 0 when you do not have an initial outflow. You typically have an outflow for capital budgeting problems. When you use the cash flow function on your calculator to calculate the PV of dividends or free cash flows, CF0 = 0.
If you’re solving an NPV or IRR question, the CFO is your initial investment. It’s a negative number.
To keep it simple, think of negative numbers as cash outflows from your bank account. And monies earned from the project as cash inflows so they are positive numbers.
On the exam you might have one year, say year 2 on a 5 year cash flow problem, where there is a further investment required by you in addition to an outflow of money back to you. So in that case, for that year you use the “net” number (positive or negative when you combine the 2 flows, whichever is bigger) as the number for that year. In this 5 year example, the year 5 cash flow is positive because it’s your return of money. For IRR calculations, it’s equal to the annual profit that year PLUS the original investment repaid. So it’s the total residual value of the investment. Cheers good luck you got this 