User:Dr. Marcous David/sandbox

Definition of 'Net Present Value - NPV'

The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.

NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.

Calculation Methods and Formulas The major component of NPV is the present value of net cash inflows which may be even (i.e. equal cash inflows in different periods) or uneven (i.e. different cash flows in different periods). Where net cash inflows are even, present value can be easily calculated by using the present value formula of annuity. However if net cash inflows are uneven we need to calculate the present value of each individual cash inflow separately. Thus we have two formulas for the

Calculating of NPV: When cash inflows are Even: NPV = R × 	1 − ( 1 + i )-n	 − Initial Investment i

In the above formula, R is the net cash inflow expected to be received each period; i is the required rate of return per period; n are the number of periods during which the project is expected to operate and generate cash inflows.

When cash inflows are uneven: NPV = 	 	R1	 + 	R2	 + 	R3	 + ... − Initial Investment ( 1 + i )1		( 1 + i )2		( 1 + i )3 Where, i is the target rate of return per period; R1 is the net cash inflow during the first period; R2 is the net cash inflow during the second period, R3 is the net cash inflow during the third period, and so on ...

Decision Rule Accept the project if its NPV is positive. Reject the project having negative NPV. While comparing two or more exclusive projects, all having positive NPV, accept the one with highest NPV.