Cashflow: Income vs Cash Flow

Suppose you face a MARR of 10% and have a two year planning horizon, i.e., you only consider years zero and one.

You are considering an asset that that increase net income by $5,000 in both years, but decreases net cashflow in year zero by $20,000 and increases net cash flow by $18,000 in year one, would you buy it?

Question options:

  • Yes
  • Yes, the present worth of net income is clearly positive
  • No
  • No, the present worth of net income is clearly positive.

Answer:

The real point of this question is to test if you know which summary of the benefits to watch. You should be looking at net cash flow rather than net income. The reason is that net cash flow measures what resources you have available to you when. Net income missing things like, the initial cost of assets or loan principal payments.

So, looking at the present worth of cash flow you see, $P= -20K + \frac{18K}{1.1}$, which is less than zero. By the present worth criteria it is a bad idea, so the best answer is, "No". Please note that, "No, the present worth of net income is clearly positive." gives the right decision but the reference to net income makes it wrong.

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