Net Present Value (NPV)
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== Big Idea == | == Big Idea == | ||
| − | Project business case development is a critical point in the initial stage of the project where it uses to obtain the approval for investing the project by presenting the benefits, cost, and risk associated with alternative options. The business case is produced by the client or the sponsor of the project and the directorate of an organization uses this document to accept or reject the case for carrying out the project <ref name="Ing" />. In a business case, financial appraisal plays a key role to answer the fundamental economic questions of whether an investment should be made and which project should be chosen among a selection of different alternatives. Because the task of financial appraisal is to predict the financial effects of planned investment and to present the data in order to get critical investment decisions <ref name="Häcker" />. The net present value method is one of the most frequently used approaches in the financial appraisal of a project <ref name="Häcker" /> <ref name="Konstantin" />. | + | Project business case development is a critical point in the initial stage of the project where it uses to obtain the approval for investing the project by presenting the benefits, cost, and risk associated with alternative options <ref name="PRINCE2">. The business case is produced by the client or the sponsor of the project and the directorate of an organization uses this document to accept or reject the case for carrying out the project <ref name="Ing" />. In a business case, financial appraisal plays a key role to answer the fundamental economic questions of whether an investment should be made and which project should be chosen among a selection of different alternatives. Because the task of financial appraisal is to predict the financial effects of planned investment and to present the data in order to get critical investment decisions <ref name="Häcker" />. The net present value method is one of the most frequently used approaches in the financial appraisal of a project <ref name="Häcker" /> <ref name="Konstantin" />. |
=== What is NPV? === | === What is NPV? === | ||
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<ref name="LOCK">LOCK, D., ''Project management. 10th edition'', (Farnham, Surrey, England, Gower Pub., 2013).</ref> | <ref name="LOCK">LOCK, D., ''Project management. 10th edition'', (Farnham, Surrey, England, Gower Pub., 2013).</ref> | ||
<ref name="Žižlavský">Žižlavský, O., ''Net present value approach: method for economic assessment of innovation projects. Procedia-Social and Behavioral Sciences'', 19th International Scientific Conference, Economics and Management, 156 (2014), pp. 506-512.</ref> | <ref name="Žižlavský">Žižlavský, O., ''Net present value approach: method for economic assessment of innovation projects. Procedia-Social and Behavioral Sciences'', 19th International Scientific Conference, Economics and Management, 156 (2014), pp. 506-512.</ref> | ||
| + | <ref name="PRINCE2">AXELOS, ''Managing Successful Projects with PRINCE2'', 6th Edition, The Stationery Office Ltd, https://ebookcentral.proquest.com/lib/DTUDK/detail.action?docID=4863041. (2017), pp. 506-512.</ref> | ||
</references> | </references> | ||
Revision as of 16:56, 17 March 2022
Written by Deepthi Tharaka Parana Liyanage Don- s203116
Abstract
Financial appraisal is a method used to evaluate whether a proposed project or portfolio of investment projects is worthwhile by considering the benefits and costs that result from its execution [1]. Investment decisions of the management are critical to a company since it decides the future of the company. This article discusses the net present value (NPV) method which is widely used in the financial appraisal. NPV is a dynamic financial appraisal method that considers the time value of money by applying discounting to all future payment series during the investment period [1]. In simple terms, the net present value is the difference between the project's future incoming and outgoing cash flows at present time. The calculation of the NPV starts by determining the net cash flows from the difference of future incoming cash flows and outgoing cash flows for each period of an investment. After the net cash flow for each period is calculated, the present value (PV) of each one is achieved by discounting using a suitable discount rate. Net present value is the cumulative value of all the discounted future net cash flows [1] [2].
Firstly, this article discusses the idea behind the net present value method. Then this introduces the NPV calculation method [1] and describes the importance of choosing the suitable discount rate [3]. Also, it discusses the other NPV formula for special cases such as annuity and perpetuity. Then it highlights the decision criteria behind NPV and explains it with real-life applications. Finally, it critically reflects on the limitations [4] of this method and briefly highlights the key references used in this article.
Big Idea
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