Overview of Net Present Value
Net present value is one of the most important capital budgeting techniques. It is used extensively in different fields of capital budgeting. It is normally employed in order to measure the financial performance of projects that have been going on for a longer period of time.
Use of Net Present Value Net present value is mainly used in order to determine if there has been a surfeit of cash flow in a particular project. The net present value also determines if there has been a shortage in the cash flows in the context of a particular business undertaking.
Equational Representation of Net Present Value
Following is a numerical presentation of net present value:
NPV = ?nt=1Ct/(1+r)t – C0
In this formula:
t represents the time period for cash flow
Ct represents the total quantity of cash flow at the time period t
n represents the complete time period for the project
C0 represents the capital that has been provided at the start of time of investment
r represents the rate of discount
Importance of Net Present Value
The net present value points to the value addition, a particular business undertaking may be making to a company. Normally if the net present value is positive it is assumed that the project would increase the corporate value of the organization. In such cases the company undertakes the particular project.
When the net present value of a project is negative it is understood that the project is least likely to make any value addition to the firm’s economic status. Under such circumstances the particular company does not approve the project.
The condition where the net present value of a project is neither negative nor positive is the diciest. It is for sure that the particular project would not add to the company’s economic value. In these situations the companies use other techniques to determine the fate of the project.
The present day companies also use the following techniques for the purpose of capital budgeting:
Internal Rate of Return
Cost Benefit Analysis
Modified Internal Rate of Return
Real Option Method
Last Updated on : 27th June 2013