Net Present Value (NPV)
Contents |
Abstract
Big Idea
Project business case development is a critical point in a project where it gives a justification for undertaking a project, in terms of evaluating the benefits, cost, and risk of alternative options and the rationale for the preferred solution. Its purpose is to obtain management commitment and approval for investment in the project. 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. The task of financial appraisal is to forecast the financial effects of a planned investment and to present the data in such a way that a a reasoned investment decision can be reached.
The net present value (NPV) method is the most frequently used approach in the financial appraisal of a project.
What is NPV?
The net present value (NPV) is the difference between the present value of all future incoming cash flows and the present value of all future outgoing cash flows. NPV is a widely used method in the financial appraisal that considers the time value of money by applying discounting and compounding of all payment series during the investment period. Time value of money is that money you have in hand now is more valuable than the money you collect later on. That is because you can use it to make more money by running a business, buying something now and selling it later for more, or simply putting it in the bank and earning interest. Future money is also less valuable because inflation erodes its buying power.
Assumptions of NPV
The NPV of a project is calculated based on the following assumptions:
- A rupee in future will not worth as much as a rupee today. So all the future cash flows are translated to present value by discounting them at the cost of capital.
- The inflow or outflow of cash other than the initial investment occur at the end of each period.
- The discount rate or cost of capital remains same throughout the life of the project.
- The cash generated by a project is immediately reinvested at the cost of capital.
Applications
Limitations
Annotated Bibliography
Reference Example: According to scientists, the Sun is pretty big.[1] The Moon, however, is not so big.[2]
References
- ↑ E. Miller, The Sun, (New York: Academic Press, 2005), 23–25.
- ↑ R. Smith, "Size of the Moon", Scientific American, 46 (April 1978): 44–46.
Actual Reference: According to scientists, the Sun is pretty big.[1] The Moon, however, is not so big.[2]
References
- ↑ Häcker J., Ernst D. Investment Appraisal. In: Financial Modeling. Global Financial Markets., (Palgrave Macmillan, London, 2017), https://doi.org/10.1057/978-1-137-42658-1_8
- ↑ R. Smith, "Size of the Moon", Scientific American, 46 (April 1978): 44–46.
