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Net present value (NPV)

Net present value (NPV)

• Net present value is the sum of the present values of all the positive cash flows minus the sum of the present values of all the negative cash flows.
• Interpretation: When the discount rate applied is an appropriate hurdle rate, it measures the contribution of the project to shareholder wealth.
• Decision rule: Accept positive NPV projectsthey increase shareholder wealth.

Focus On: CalculationsSteps in calculating NPV

1. Identify all the incremental cash flows associated with the project.
2. Determine the appropriate discount rate.
3. Using that discount rate, calculate the present value of all of the inflows(positive sign) and outflows (negative sign).
4. Sum the present values togetherthe result is the project’s NPV.
5. Apply the NPV decision rule.-If you have mutually exclusive projectsaccept the one with the highest NPV.

Focus On: Calculations

Consider Project A with the following cash flows:

• The NPV for this project is…?
• Decision?

Consider Project B with the following cash flows:

• The NPV for this project is…?
• Decision?