Net present value

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  • 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
    • 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
    • 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

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