> Both you and Doug have hit on the problem I'm having. First,
what management is trying to do is to determine how this
purchase could affect
what they call 'cost savings'. So they've isolated it from
current inflows
and outflows. The problem is that they calculate *separate* NPVs
for the
affected income flows (cost savings) and for capital. Then they
subtract
the one NPV from the other to get the total NPV. This seems
rather bizarre
to me.>>
If I understand you, there's nothing wrong with it. Suppose income for a period is 100 and costs are 50, and the discount factor is 1.2. Well, (100-50)/1.2 is the same as 100/1.2 - 50/1.2. Nothing wrong with that. It's potential purpose is to be able to compare diverse costs and incomes from different periods in the same terms, e.g., present value.
> The depreciation is considered straight-line (so that after 10
years, $5 million). So I guess the question is, is the NPV
appropriate as a
measure applied to capital by itself (since the 'net' part seems
to be
meaningless) and if so, what does it mean? I should also say that
I tried
straight Present Value to calculate this and am no further ahead.
This
corporation uses a lot of weird and wonderful methods of costing
(for
example, some union benefit packages cost 175% of wages - we
wish!) so it
wouldn't surprise me if this is another one. Thanks again >
NPV applies to flows, but if there is some capital left at the end of the period in question, e.g., ten years, then the present value of the remainder is part of the story of the assets value over ten years, in addition to net cash flow.
The point of depreciation in this context lies in using a period shorter than the life of the asset. Over the full life of the asset, depreciation is irrelevant -- only cash, as DD alluded. But if we're talking ten out of 40 years, then after ten years there is still some capital left no NPV needs to take depreciation into account in recognition of that.