Net Present Value: The Advantages Of Net Present Value

10. What is the net present value (NPV) of a long-term investment project? Describe how managers use NPVs when evaluating capital budget proposals.

NPV analysis uses future cash flows to estimate the value that a project could add to a firm’s shareholders. A company director or shareholders can be clearly provided the present value of a long-term project by this approach. By estimating a project’s NPV, we can see whether the project is profitable. Despite NPV analysis is only based on financial aspects and it ignore non-financial information such as brand loyalty, brand goodwill and other intangible assets, NPV analysis is still the most popular way evaluate a project by companies.

2. Net Present Value – Secondly, Peter needs to investigate the Net Present Value (NPV) of each project scenario, i.e. job type, gross margin, and # new diamonds drills purchased. The NPV will measure the variance of the present value of cash outflow (drilling equipment investment) versus the future value of cash inflows (future profits), at the benchmark hurdle rate of 20%. A positive NPV associated with the investment means that the investment should be undertaken as it exceeds the minimum rate of return. A higher NPV determines which project scenario will have the highest return on cash flow, hence determining the most profitable investment in terms of present money value.

The NPV compares the inflow of cash against the flow of cash to make the investment. With the cash flows occurring over a period of time, NPV also takes into account the cost of capital. The cost of capital or discount rate allows the company to weigh the present value of capital today with the investment capital’s present value. Futronics Inc. investment would have an NPV of $138,642.39. The NPV of this investment would add value to Futronics Inc.’ worth.

A financing project should be accepted if, and only if, the NPV is exactly equal to zero.

Net present value (NPV) is the present value (PV) of an investment’s future cash flows minus the initial investment (“Net Present Value,” 2011).   The high-tech alternative has a PV of $13,940,554.49 with an initial investment of $7,000,000, so the NPV = $6,940,554.49.   This positive NPV indicates to

1) Incremental cash flows are the cash flows that should be used in calculating the NPV of a project. The cash flows are changes in cash flows that occur as a direct consequence of accepting a project, not the cash flows that the company is already receiving.

Cash inflows and outflows can occur at any time during the project. The NPV of the project is the sum of the present values of the net cash flows for each time period t, where t takes on the values 0 (the beginning of the project) through N (the end of the project).

Account for time. Time is money. We prefer to receive cash sooner rather than later. Use net present value as a technique to summarize the quantitative attractiveness of the project. Quite simply, NPV can be interpreted as the amount by which the market

Net Present Value (NPV) calculates the sum of discounted future cash flows and subtracting that amount with the initial investment of the project. If the NPV of a project results in a positive number, the project should be undertaken. It is the most widely used method of capital budgeting. While discount rate used in NPV is typically the organization’s WACC, higher risk projects would not be factored in into the calculation. In this case, higher discount rate should be used. An example of this is when the project to be undertaken happens to be an international project where the country risk is high. Therefore, NPV is usually used to determine if a project will add value to the company. Another disadvantage of NPV method is that it is fairly complex compared to the other methods discussed earlier.

The ARR also fails to consider the timing of profit as a 22% ARR in 12 years may be better than a 18% rate of return for 8 years, ignoring that the longer the term of the project, the greater the risk involved.

b. Independent projects are ones that can both be accepted without either affecting the other. Mutually exclusive projects are ones that if one is accepted the other must be rejected.

This analysis will determine whether or not the project is worth pursuing using a net present value (NPV) approach.

The Net Present Value is one of the techniques that are used by firms when evaluating which investment proposals to take on board and which ones to reject. The net present value is calculated by discounting all flows to the present and subtracting the present value of all inflows.

Profitability index (PI) and net present value (NPV) is two parameters that use in an investment. However, there are specific differences among them. In fact the, profitability index is considered to be less advantageous than net present value method this is because profitability index has its limitation which is more when compared to net present value.