Session 13: Incremental Cashflows and Dealing with Uncertainty
from Aswath Damodaran Hosted by Aswath Damodaran
In this class, we started the move from cash flows to incremental cash flows by asking two questions: (1) What will happen if you take the project and (2) What will happen if you do not? If the answer is the same to both questions, the item is not incremental. That is why "sunk" costs, i.e., money already spent, should not affect investment decision making. It is also the reason that we add back the portion of allocated G&A that is fixed and thus has nothing to do with this project. Finally, we looked at two time-weighted, incremental cash flow approaches to calculating returns, NPV and IRR, and used them to analyze the Rio Disney theme part. In the second half of the class, I talked about why currency choices should not affect investment decisions (but sometimes do) as well as ways of dealing with uncertainty, ranging from payback to simulations. If, like me, you find yourself fascinated by simulations, but your statistics is a little rusty, you can try this paper I have on statistical distributions.https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3237778 You don’t have to read the whole paper, just the appendix. I have attached the post class test for today, with the solution. In the final part of the class, we looked at time weighting cash flows, why and how we do it. Slides: https://pages.stern.nyu.edu/~adamodar/podcasts/cfspr23/session13slides.pdfPost class test: https://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session13test.pdfPost class test solution: https://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session13soln.pdf
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