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•68 The 100 Greatest Business Ideas of All Time

‘This consists of a cost–benefit analysis and some risk analysis to assess the
downside of things going wrong. Finally it lands on the desk of financial controllers,
who put the numbers from the cost–benefit analysis into a discounted cashflow. It is
a useful, though not vital, test of all projects. It allows us to compare one strategy
with another, or, for example, the relative financial merit of buying a computer
against the totally different proposal to open more depots. It is important, and if you
are going to work with us you had better learn how it works. Having said that, if
projects look good to the MD and me, they usually go ahead.’

George went through the learning process.

Why do we need discounted cashflow?

Once managers have done some sort of cost–benefit analysis on how they would like
the company’s resources to be spent, their bosses have the job of deciding which
ones to accept and which to reject. How do they compare one project with another?

Consider the following projects (both of five years duration)

Initial investment Project 1 Project 2
Expected annual earnings
(before depreciation) £10,000 £10,000
Year 1
Year 2 2,000 5,000
Year 3 3,000 6,000
Year 4 5,000 7,000
Year 5 7,000 4,000
Total 8,000 3,000
Net earnings over 5 years 25,000 25,000
15,000 15,000