Net present value
- Created by: noe
- Created on: 23-09-20 08:23
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- NPV
- Discounted cash flow
- Method of investment appraisal that takes interest rates into account by calculating the present value of future income
- Money in the future worth less than the same amount now as money available today could be invested and it could earn interest
- Discount tables used to show by how much a future value must be multiplied to calculate its present value
- E.g. If an investment project is predicted to give a net cash flow of €10 000 in three years' time and the discount rate was 10%, the €10 000 would have to be multiplied by 0.75.
- The higher the rate of discount, the less the present value of cash flow in the future
- The further into the future the cash flow or earnings from an investment project, the less their present value
- Method of investment appraisal that takes interest rates into account by calculating the present value of future income
- Calculates the rate of return on an investment project taking into account the effects of interest rates and time
- = present value - initial cost
- E.g. if the total cost of a project is €50,000 and the expected net cash flow after discounting is €42 000, the NPV will be (€8000) meaning it is unprofitable
- When comparing projects, the project with the highest NVP should be chosen
- = present value - initial cost
- Advantages
- Correctly accounts for the value of future earnings by calculating present values
- Discount rate can be changes as risk and conditions in financial markets change
- Drawbacks
- Calculation more complex
- The higher the rate of discount, the less projects will be profitable
- Discounted cash flow
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