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Net Present Value: Presentation By: DEEKSHA (21) SADIQ (22) Shaswathi (23) Sathpreeth

Net present value (NPV) is a method used to evaluate the profitability of an investment or project. NPV compares the present value of cash inflows to the present value of cash outflows. A positive NPV indicates that the projected earnings generated by the project or investment exceed the cost of capital and the project or investment should be accepted. To calculate NPV, future cash flows are discounted back to the present using a discount rate, usually the weighted average cost of capital. Projects with a positive NPV add value to the firm and should be accepted, while projects with a negative NPV subtract value from the firm and should be rejected.

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95 views13 pages

Net Present Value: Presentation By: DEEKSHA (21) SADIQ (22) Shaswathi (23) Sathpreeth

Net present value (NPV) is a method used to evaluate the profitability of an investment or project. NPV compares the present value of cash inflows to the present value of cash outflows. A positive NPV indicates that the projected earnings generated by the project or investment exceed the cost of capital and the project or investment should be accepted. To calculate NPV, future cash flows are discounted back to the present using a discount rate, usually the weighted average cost of capital. Projects with a positive NPV add value to the firm and should be accepted, while projects with a negative NPV subtract value from the firm and should be rejected.

Uploaded by

deekshans
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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NET PRESENT VALUE

Presentation By:

DEEKSHA (21)
SADIQ (22)
SHASWATHI (23)
SATHPREETH (24)
History
• Net present value as a valuation
methodology dates at least to the 19th
century. Karl Marx refers to NPV as fictitious
capital, and the calculation as capitalizing.
• The forming of a fictitious capital(such as
stocks and securities)is called capitalizing .
What is NPV?

• NPV of the financial decision is the difference between the present


value of inflows & the present value of outflows.

• NPV is an indicator of how much value an investment or project adds


to the firm.

• Used for capital budgeting, and it measures the excess or shortfall of


cash flows, in present value terms, once financing charges are met.

• Programs with a positive NPV are generally cost effective.

• Programs with negative NPV are generally not cost effective.


Properties of NPV rule
• Net present values are additive
• Intermediate cash flows are invested at cost
of capital
• NPV calculation permits time varying
discount rates
• NPV of a simple project decreases as
discount rate increases
How to calculate NPV?
• FORMULA:

Ct=cash inflow in the period t


C0=cash outflow of today
K=required rate of return
T=time period
The discount rate
• The rate used to discount future cash flows to the
present value is a key variable of this process.
• For example, the capital required for Project A can earn
five percent elsewhere, use this discount rate in the
NPV calculation to allow a direct comparison to be
made between Project A and the alternative.
• For some professional investors, their investment funds
are committed to target a specified rate of return. In
such cases, that rate of return should be selected as the
discount rate for the NPV calculation. In this way, a
direct comparison can be made between the
profitability of the project and the desired rate of
return.
NPV in decision making
• NPV is an indicator of how much value an
investment or project adds to the firm. With
a particular project, if Rt (the net cash flow) is
a positive value, the project is in the status of
discounted cash inflow in the time of t. If Rt
is a negative value, the project is in the status
of discounted cash outflow in the time of t.
Appropriately risked projects with a positive
NPV could be accepted.
If It means Then
NPV>0 the project may be
accepted
the investment would add value to
the firm

NPV<0 the investment would subtract value the project should be


from the firm rejected

NPV=0 the investment would neither gain We should be indifferent in


nor lose value for the firm the decision whether to
accept or reject the project.
This project adds no
monetary value.
Example:
• This project will have an immediate cash
outflow of $100,000 (which might include
machinery, and employee training costs).
Other cash outflows for years 1–6 are
expected to be $5,000 per year. Cash inflows
are expected to be $30,000 each for years 1–
6. All cash flows are after-tax, and there are
no cash flows expected after year 6.
The required rate of return is 10%.
Year Cash flow Present value

T=0 -1,00,000/(1.10)0 -$1,00,000

T=1 30,000-5000/(1.10)1 $22,727

30,000-5000/(1.10)2
T=2 $20,661

30,000-5000/(1.10)3
T=3 $18,783

30,000-5000/(1.10)4
T=4 $17,075

30,000-5000/(1.10)5
T=5 $15,523

30,000-5000/(1.10)6
T=6 $14,112

TOTAL 1,08,881
 The decision should be: The sum of all these
present values is the net present value,
which equals $8,881.52.
 Since the NPV is greater than zero, it would
be better to invest in the project than to do
nothing, and the corporation should invest in
this project if there is no mutually exclusive
alternative with a higher NPV.
Advantages AND Disadvantages

Advantages:-
• Recognizes the risk associated with future cash flow
• Time value of money concept is taken into account

Disadvantages:-
• Expressed in absolute rather than relative terms.
• Does not consider life of project
• Does not tell timing of positive NPV
• Very sensitive to discount rate

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