A Business Encyclopedia

Net Present Value

Definition: The Net Present Value or NPV is a discounting technique of capital budgeting wherein the profitability of investment is measured through the difference between the cash inflows generated out of the cash outflows or the investments made in the project.

The formula to calculate the Net Present value is:

Net present value = nt=1   Ct / (1+r)t – C0

Where, Ct = cash inflow at the end of year t
n= life of the project
r= discount rate or the cost of capital
Co= cash outflow

Accept – Reject Criteria: If the NPV is positive, the project is accepted.

Merits of Net Present Value

  1. It takes into consideration the Time Value of Money.
  2. It measures the profitability of the entire project by considering the profits throughout its life.
  3. It is easy to alter the discount rate, by just changing the value of the denominator.
  4. This method is particularly suitable for the mutually exclusive projects.
  5. It is consistent with the objective of maximizing the net wealth of the company.

Demerits of Net Present Value

  1. The forecasting of cash flows is difficult because of several uncertainties involved in the operations of the firm.
  2. It is difficult to compute the discount rate precisely. And this is one of the crucial factors in the computation of net present value as with the change in the discount factor the NPV results also changes.
  3. Another problem is that it is an absolute measure, it accepts or rejects the projects only on the basis of its higher value irrespective of the cost of initial outlay.

Thus, to compute the Net Present value, a firm should determine the cash inflows and the outflows along with the discount rate or a rate of return that firm desires during the lifetime of the project.

Leave a Reply

Your email address will not be published. Required fields are marked *


Related pages

mcclelland motivation theorywhat is oligopolisticapprenticeships definitionemployee providant fundhedge knight definitionhow to find the profitability indexsample proportion distributionmm dividend theorycarrot and donkeywhat is the definition of monopoly in economicselastic demand economics definitiondefinition of geocentric theoryfeatures of monopoly in economicselectronic cheque definitionvroom meaningpoaching meansdiscounting techniques of capital budgetingfactors influencing buying decisionindifference curve and budget linemeaning of sebigross profit turnover ratiofactors that affect marketing environmentfactors influencing buying behaviouroperating profit margin ratio interpretationwhat is the meaning of mnc companyadvantages and disadvantages of long term loansloan balloon paymentmonetary policy tools definitionassumption meaning in urdudeontological ethical theory definitiondifference between lessor and lesseeforecasting methods with examplesdemerger definitionmeaning of hostile takeoverraymond cattell trait theorytransportation problem linear programmingwhat are the determinants of elasticitywhat is a diminishing marginal utilitybases market segmentationfiedler's contingency theory of leadership14 principles of management by henry fayolmicro and macro environment marketingdefinition of inventory turnover ratiovestibule training definitionsocial cost benefit analysis meaningglobal staffing approachesdemand forecasting managerial economicscamels rating systemdefine ergsegmentation definition in marketingdefine truncationmeaning of jargon in hindimonopolistic competitonformula for debtors turnover ratiomeaning of oligopoly in economicsexplain business process reengineeringdefinition stratified samplingsemantic barrierwhat is fmcg company meanswho is a participative leaderconsumer buying behavior is affected bydeontological ethical theorypiecework pay systemtravelers chequedescription of sole proprietorshipfour characteristics of oligopolymultistage sampledefine dialeticduality in lppthe nominal group techniquedefinition flankwhat is likert scale questionnaireprovident fund meaningautocratic management style definitionacquired needs theory of motivationerg motivation theoryindexation inflation