Time value applied to projects

Chapter 1 of the Quantitative methods subject derived the discounting machinery. Applying it to a project needs no new mathematics. It needs a rule for which numbers go in, and that is where decisions are actually won and lost.

Only incremental cash flows count

The test for any number: would this cash flow change if we did not do the project?

If yes, include it. If no, exclude it. Nothing else matters — not whether it appears in the accounts, not whether somebody's budget carries it.

Cash, not profit

Depreciation is not a cash flow. It is an allocation (chapter 8 of the Accounting subject), so it never belongs in the numerator of a project valuation. The capital expenditure belongs, in the year it is paid.

Depreciation does matter indirectly, through tax: it reduces taxable profit, so it reduces tax paid, and the tax saving is cash. That is the depreciation tax shield, and chapter 6 handles it properly.

Sunk costs are irrelevant

Money already spent cannot be recovered by any choice available now.

Work the problem. ₹2 crore spent on a study, ₹8 crore to finish, ₹10 crore of present value. The ₹2 crore is gone whatever you decide. The decision is ₹8 crore against ₹10 crore, which creates ₹2 crore of value. Proceed.

Now make the study cost ₹20 crore. Nothing changes. It is still ₹8 crore against ₹10 crore. The project was a disaster overall and is still worth finishing, because the alternative — stopping — recovers nothing and forgoes the ₹2 crore of value.

This is genuinely hard in practice, because abandoning a project means admitting the earlier spend was wasted. Throwing good money after bad is the error the rule prevents; refusing to finish because of what was already spent is the error it also prevents. Both are the same mistake in opposite directions.

Opportunity cost is a real cost

If the project uses land the company already owns, the land is not free. Its cost is what it could have earned otherwise — sold, leased, used for something else. That the purchase happened years ago is irrelevant; what matters is what is given up now.

The same applies to a factory running below capacity, a brand name, or a team that would otherwise be doing something else.

Allocated overhead usually is not a cost

Companies allocate head office costs across divisions. A project charged ₹50 lakh of "corporate allocation" should include it only if head office costs actually rise by ₹50 lakh because of the project.

Usually they do not; the allocation is an internal accounting convention. Including it rejects good projects. Equally, if the project genuinely needs more head office, that increment is a real cost.

Side effects count, in both directions

Cannibalisation. A new product that takes sales from an existing one has an incremental benefit of the net gain, not the gross. Ignoring this is how companies approve launches that move revenue around and add nothing.

Positive spillovers count too. A loss-making product that drives profitable sales elsewhere has an incremental value larger than its own line.

Financing costs are excluded from the cash flows

This surprises people. Interest payments do not go in the project cash flows.

The reason is that financing is handled in the discount rate. Discounting at the cost of capital already charges the project for the money it uses; subtracting interest as well would charge it twice. Chapter 9 derives the rate that does the charging.

The checklist

Item	In?
Capital expenditure	Yes, when paid
Depreciation	No — but its tax saving, yes
Sunk costs	No, ever
Opportunity cost of assets used	Yes
Allocated overhead	Only the incremental part
Working capital investment	Yes — and its release at the end
Cannibalised sales	Yes, as a reduction
Interest and loan repayments	No — handled in the discount rate
Tax on operating profit	Yes

The point

A project valuation uses incremental cash flows: everything that changes because the project happens, and nothing that does not. Sunk costs are irrelevant in both directions — they neither justify continuing nor justify stopping. Opportunity cost is real even when no money changes hands, allocated overhead usually is not, and financing costs stay out of the cash flows because the discount rate already charges for the capital.