Okay, now we're going to talk about a few things. There are other ways that companies use, other factors that corporations use sometimes to evaluate projects. And I'll talk about those in a moment. But this discussion is going to be focused around why net present value is the best one, okay. So I'm giving away the secret already that net present value is really better than the other ones that are currently being used. We'll talk about those for a moment. So what do people use to evaluate projects, other than NPV? Well, some companies use something called the book rate of return. The book rate of return is simply the book income divided by the book investment, to come up with the return. Now, as we had talked about earlier, that books and tax are significantly different. And your book investments can be much different than your actual investments. So that generally doesn't give you a very accurate result of your actual return on that investment. The other criteria people sometimes use is what they call project payback period, or we call it PP here. And that is simply, how long does it take for the cash flow to the project to return back to the corporation the investment cost. That's called profit payback period. And the third way of evaluating investment criteria, the other investment criteria that are used, is something called the internal rate of return. Now the book rate of return, BRR, and payback period have little to do with whether or not the project increases the shareholder value, because of what I just said a minute ago. But I'll show you in more detail about this in a moment. But the IRR, interestingly enough, IRR should always, always identify projects that increase the wealth of the company. If you know what some of the traps are around using IRR, then you can use the IRR correctly, [COUGH] so you don't fall into those traps. Let's look at these three criteria a little bit more. But I want to go back and do a little bit of revision of what we talked about already. Don't forget, one thing you should remember when we talk about NPV. A dollar today is worth more than a dollar in the future, because we can invest it right away. The net present value calculation, if you remember, depends solely on the forecasted cash flows and the opportunity cost of capital. Now, we can argue that the forecasted cash flows are variable or can be played around with. But let's assume that you make a reasonable forecast, and then you know the opportunity cost of capital, so there's no real variables there. So that's a big thing versus the other ways that people look at this. And remember that because net present values are calculated based upon the value today, we're calculating back to today the value of a project. They are additive, meaning that it is unlikely that you will be misled into investing in a good project that has a very positive NPV, and one that's not so good or maybe even has a negative NPV, by having somebody try to bundle them together which may still generate a positive NPV. But if you look at the fact that each project is considered independently, you would make the investment in the one that has a positive NPV, and not make the one that was a negative NPV, okay. So that's just to remember, keep in the back of your mind. So again, the book rate of return. That's equal to the book income divided by book assets, which I've already said. But cash flow and book income are very different, right. Cash outflows are classified as either capital or operating cost, right. So capital costs are put on the company's books and depreciated. So if I'm looking at the book cost of this project, it could be zero because there's no cash outflow because I'm capitalizing on the book. Now, operating costs are deducted from book income. So there's lots of things that are going on that makes book rate of return not a real meaningful way to look at investment book totals. Because it depends upon what's capitalized and what's not, and at what rate of depreciation you're using to amortize that expense over through the life of the asset. So that's book rate of return. We'll talk about the other ones next time.
