What is a project’s “net annual benefit?” Why is this measure used in evaluating permanent working capital asset decisions?
Net annual benefit is the amount by which the annual cash flow from an investment project exceeds the amount required to finance the capital invested. It is particularly useful for permanent working capital decisions for two reasons. First, since it looks only at the upcoming year it addresses the potentially troublesome assumption that changes to cash flows from permanent working capital decisions continue forever. We can make a decision based on the costs and benefits the company will experience in the next year knowing that we can undo the decision in future years should conditions change. Second, by looking at the upcoming year, it focuses our attention on opportunities to further improve the permanent working capital balance on an ongoing basis.