Net present value: Difference between revisions

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imported>Doug Williamson
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imported>Doug Williamson
(Note expressly that the negatives are netted against the positives.)
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The total [[present value]] of all of the cash flows of a proposal - both positive and negative.  
The total [[present value]] of all of the cash flows of a proposal - both positive and negative - netting off negative present values against positive ones.  


For example, the expected future cash inflows from an investment project LESS the initial capital investment outflow at Time 0.
For example, the expected future cash inflows from an investment project LESS the initial capital investment outflow at Time 0.

Revision as of 14:14, 17 November 2015

(NPV).

1.

The total present value of all of the cash flows of a proposal - both positive and negative - netting off negative present values against positive ones.

For example, the expected future cash inflows from an investment project LESS the initial capital investment outflow at Time 0.


Example

A project requires an investment today of $100m, with $120m being receivable one year from now.

The cost of capital (r) is 10% per annum.


The NPV of the project is calculated as follows:


PV of Time 0 outflow $100m

= $(100m)


PV of Time 1 inflow $120m

= $120m x 1.1-1

= $109.09m


NPV = -$100m +$109.09m

= +$9.09m


2.

In simple Net Present Value analysis the decision rule would be that:

(1) All positive NPV opportunities should be accepted.

(2) All negative NPV opportunities should be rejected.


So the project in the example above would be accepted - on this basis - because its NPV is positive, namely +$9.09m.


However this assumes the unlimited availability of further capital with no increase in the cost of capital.

A more refined decision rule is that:

(1) All negative NPV opportunities should still be rejected; while

(2) All positive NPV opportunities remain eligible for further consideration (rather than automatically being accepted).


See also