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What is NPV
NPV is an acronym that stands for Net Present Value.
Uses of NPV
In Capital budgeting or financial budgeting we are privy to use different metrics that inform us whether the investment is a profitable one or not. Most of these financial metrics use DCF or Discounted Cash Flows techniques in ascertaining our results.
An Example using NPV
Say someone offered you an opportunity to invest with an initial cost of $1000 and that person promised to pay four sums of money at the end of each of the next four years in the amounts of $500, $400, $300 and $100
Looking at the bare numbers we would think that the sum of $1300 provides us a surplus amount of $300 on our investment of $1000. Thus a naive person would jump to make that investment.
Here is what such a person overlooked. Something called Time Value of Money. The $500 at the end of next year is not worth $500 in today's money since money depreciates in value as time goes by.
This leads us to make sure that cash inflows in future are discounted at a rate (which for companies is the WACC or weighted average cost of capital and for you it may be the interest rate a bank offers to savings account holders if you were to invest the $1000 with them.) This interest rate or the discount rate is your opportunity cost, meaning what you will be willing to give up to gain more benefits.
Say now that the local branch of Chase Manhattan bank offers you 6% interest rate for a savings account. Now if you invested the $1000 in savings account, what would be your return on investment if you kept the money in bank for 4 years.
FV = R. (1+i)n
FV = 1000 (1+0.06)4
FV = 1000 (1.06)4
FV = 1000 (1.26247696)
FV = $1262.48
The savings account will earn you $262.48
Keeping the interest rate as our cost of capital or the discount rate, let us see how much is our initial investment worth if we invested in it instead of a savings account.
Discounted Cash Flows
$500/(1+0.06)1 = $500/1.06 = $471.70
$400/(1+0.06)2 = $400/1.1236 = $356.00
$300/(1+0.06)3 = $300/1.191016 = $251.89
$100/(1+0.06)4 = $100/1.26247696 = $79.21
Sum of DCF = $417.70 + $356 + $251.89 + $79.21
Sum of DCF = $1158.80
NPV = $1,158.80 - $1,000
NPV = $158.80
Our investment in the project will earn us $158.80 which seems less than what the bank will pay us on our savings which is $262.48. But then we would need to bring $262.48 in present value terms since $262.48 is to be realized in 4 years time
Here is how
$262.48/(1+0.06)4 = $262.48/1.26247696 = $207.91
We are still better off with investing in Savings account that will get us $207.91 instead of $158.80 with our sample project
What else can I help you with?
What does the term npv stand for?
The most common use of the acronym NPV is to refer to net present value. Net present value is the sum of the present values of individual cash flows of the same entity.
Does lower WACC equal lower NPV?
no it increases npv
The weighted scoring approach avoid the drawbacks of the NPV approach?
The weighted scoring approach avoid the drawbacks of the NPV approach?
How do you create NPV in 2006 Suzlon Company?
Suppose i have selected Suzlon company so how can i create NPV in 2006 and how to analysis annual Report of 2006.
What are the advantages of IRR over NPV?
Elyse Douglas.
What does the term npv stand for?
The most common use of the acronym NPV is to refer to net present value. Net present value is the sum of the present values of individual cash flows of the same entity.
Does lower WACC equal lower NPV?
no it increases npv
What happens to NPV when cost of capital increased?
NPV decreases when the cost of capital is increased.
The NPV assumes cash flows are reinvested at the?
The NPV assumes cash flows are reinvested at the: A. real rate of return B. IRR C. cost of capital D. NPV
Why is the NPV approach often regarded to be superior to the IRR method?
Why is the NPV approach often regarded to be superior to the IRR method?
The weighted scoring approach avoid the drawbacks of the NPV approach?
The weighted scoring approach avoid the drawbacks of the NPV approach?
Does the npv of future cash flows increase or decrease as the discount rate increases?
NPV decreases with increasing discount rates.
IRR VS NPV?
IRR: Internal rate return NPV: Net present value Both are measure of the viability of a project(s) You can have multiple IRR (because of discontinued cash flows) but you always have one NPV.
Fullform of NPV?
Net Present Value
What happens to NPV if the cost of capital changes?
The cost of capital is inversely proportional to the NPV. As capital costs increase (i.e. the interest rate increases), NPV decreases. As capital costs decrease (i.e. the interest rate decreases), NPV increases. You can see the relationship in the following equation: NPV = a * ((1+r)^y - 1)/(r * (1+r)^y) Where: NPV = Net Present Value (The present value of a future amount, before interest earnings/charges) a = Amount received per year y = Number of years r = Present rate of return
How do you create NPV in 2006 Suzlon Company?
Suppose i have selected Suzlon company so how can i create NPV in 2006 and how to analysis annual Report of 2006.
Why the NPV of a relatively long term project is more sensitive to changes in the cost of capital than is the NPV of a short term project?
due to the uncertainty
