This chapter discusses the details and nuts and bolts issues of making investment decisions and applying the NPV rule in practice. Specifically, the chapter focuses on three tasks faced in practical capital budgeting. The first issue is to determine what should be discounted to compute the NPV. The answer, of course, is cash flows relevant to the project. The second task is the compilation of the “bottom-line” cash flow forecast. The chapter describes the items to be included and also excluded and gives a detailed example.

The third problem in the application of the NPV rule arises when one has to modify the NPV rule to suit special situations relating to mutually exclusive project choices. This often requires converting the NPV into equivalent annual costs or benefits for the project choice. A typical example might involve alternative proposals, with different project lives, for the replacement of existing machinery. The proper evaluation in this case will be to compare the alternatives in terms of the equivalent annual costs rather than the total costs for each alternative. This technique finds extensive application in a number of different situations. The chapter also presents situations where the NPV rule has to be modified because of the interactions between investment projects and other activities or decisions of the firm. These project interactions have to be carefully sorted out and included in the project analysis and decision.