Net Present Value (NPV)

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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

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 Cite error: Closing </ref> missing for <ref> tag [2] [5] [6] [7] [4] [8] [3] [9]

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  1. ↑ 1.0 1.1 1.2 1.3 Cite error: Invalid <ref> tag; no text was provided for refs named Häcker
  2. ↑ 2.0 2.1 Ferrari, C., Bottasso, A., Conti, M. and Tei, A., Ch. 5 - Investment Appraisal. In: Economic role of transport infrastructure: Theory and models, (Elsevier, 2018), pp. 85-114, https://doi.org/10.1016/C2016-0-03558-1
  3. ↑ 3.0 3.1 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.
  4. ↑ 4.0 4.1 Bora, B., Comparison between net present value and internal rate of return, International Journal of Research in Finance and Marketing, (2015), 5(12), pp.61-71
  5. ↑ Konstantin P. and Konstantin M., Ch. 4 - Investment Appraisal Methods. In: Power and Energy Systems Engineering Economics, (Springer, Cham, 2018), pp. 39-64, https://doi.org/10.1007/978-3-319-72383-9_4
  6. ↑ Poggensee K. and Poggensee J., Ch. 3 - Dynamic Investment Calculation Methods. In: Investment Valuation and Appraisal, (Springer, Cham, 2021), pp. 85-140, https://doi.org/10.1007/978-3-030-62440-8
  7. ↑ Ing E. and Lester A., Ch. 5 - Business case and Ch. 6 - Investment Appraisal. In: Project Management, Planning and Control. 7th Edition, (Elsevier, 2017), pp. 25-36, https://doi.org/10.1016/B978-0-08-102020-3.00006-1
  8. ↑ LOCK, D., Project management. 10th edition, (Farnham, Surrey, England, Gower Pub., 2013).
  9. ↑ 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.
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