A.) Constructing the relevant cash flows for project evaluation is important and sometimes difficult. Some financial instruments, such as bonds and mortgages, present a fairly well-defined set of cash flows. Other financial instruments, such as options, futures, and derivatives, can have complex cash flows dependent on several factors. Most business projects require as much art as science in projecting the cash inflows and cash outflows of a project, including the effects of proposals on existing undertakings.

Projects with a Positive NPV Add Value to the Firm

The net present value, or NPV, is one of the most common methods used to evaluate investments. At its simplest, NPV is the present value computed by using the firm's cost of capital as the discount rate of cash inflows, minus the present value of cash outflows, including the initial investment.

One way to account for different levels of risk between competing projects is to increase the cost of capital by some amount to reflect the higher risk.

Projects with an IRR Greater than the Cost of Capital Add Value to the Firm

The IRR is the discount rate that makes the present value of the cash inflows equal to the present value of the cash outflows. This is the same as saying that the IRR is the discount rate that makes the net present value equal to zero.

Is the certainty of the cash flow would dictate the risk level used? That is one way. How do you then adjust for this risk? (what is the easiest way)

B.) If one favor NPV, how can I measure 2 projects if they are mutually exclusive (meaning I can't do both)? What happens if the one project is for 4 years and has a slightly lower NPV compared to the other project which is for 5 years? Will I always choose the highest NPV? What adjustments might I make? PLEASE EXPLAIN