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Defining NPV Calculating the NPV Interpreting the NPV Advantages of the NPV method Disadvantages of the NPV method NPV Profiles Net Present Value Capital Budgeting > Net Present Value Free to share, print, make copies and changes. Get yours at ect&utm_source=boundless
Because of the time value of money, cash inflows and outflows only can be compared at the same point in time. NPV discounts each inflow and outflow to the present, and then sums them to see how the value of the inflows compares to the other. A positive NPV means the investment is worthwhile, an NPV of 0 means the inflows equal the outflows, and a negative NPV means the investment is not good for the investor. Defining NPV Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_94&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Airplane View on Boundless.com Capital Budgeting > Net Present Value
Cash inflows have a positive sign, while cash outflows are negative. To find the NPV accurately, the investor must know the exact size and time of occurrence of each cash flow. This is easy to find for some investments (like bonds), but more difficult for others (like industrial machinery). Investors use different rates for their discount rate such as using the weighted average cost of capital, variable rates, and reinvestment rate. Calculating the NPV Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_94&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Net Present Value (NPV) Formula View on Boundless.com Capital Budgeting > Net Present Value
When inflows exceed outflows and they are discounted to the present, the NPV is positive. The investment adds value for the investor. The opposite is true when NPV is negative. A NPV of 0 means there is no change in value from the investment. In theory, investors should invest when the NPV is positive and it has the highest NPV of all available investment options. In practice, determining NPV depends on being able to accurately determine the inputs, which is difficult. Interpreting the NPV Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_94&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Machinery View on Boundless.com Capital Budgeting > Net Present Value
When NPV is positive, it adds value to the firm. When it is negative, it subtracts value. An investor should never undertake a negative NPV project. As long as all options are discounted to the same point in time, NPV allows for easy comparison between investment options. The investor should undertake the investment with the highest NPV, provided it is possible. An advantage of NPV is that the discount rate can be customized to reflect a number of factors, such as risk in the market. Advantages of the NPV method Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_94&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess NPV Decision Table View on Boundless.com Capital Budgeting > Net Present Value
NPV is based on future cash flows and the discount rate, both of which are hard to estimate with 100% accuracy. There is an opportunity cost to making an investment which is not built into the NPV calculation. Other metrics, such as internal rate of return, are needed to fully determine the gain or loss of an investment. Disadvantages of the NPV method Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_94&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Medicine View on Boundless.com Capital Budgeting > Net Present Value
The NPV Profile is a graph with the discount rate on the x-axis and the NPV of the investment on the y-axis. Higher discount rates mean cash flows that occur sooner are more influential to NPV. Since the earlier payments tend to be the outflows, the NPV profile generally shows an inverse relationship between the discount rate and NPV. The discount rate at which the NPV equals 0 is called the internal rate of return (IRR). NPV Profiles Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_94&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess NPV Profile View on Boundless.com Capital Budgeting > Net Present Value
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Key terms cash flow The sum of cash revenues and expenditures over a period of time. cash inflow Cash that is received by the investor. For example, dividends paid on a stock owned by the investor is a cash inflow. cash outflow Any cash that is spent or invested by the investor. discount rate The interest rate used to discount future cash flows of a financial instrument; the annual interest rate used to decrease the amounts of future cash flow to yield their present value. gain (or loss) If an investment earns more value than it costs, the difference is the gain. If it costs more than it earns, the difference is a loss. internal rate of return IRR. The rate of return on an investment which causes the net present value of all future cash flows to be zero. Opportunity cost The cost of an opportunity forgone (and the loss of the benefits that could be received from that opportunity); the most valuable forgone alternative. variable something whose value may be dictated or discovered. Free to share, print, make copies and changes. Get yours at Capital Budgeting
NPV Profile The NPV Profile graphs how NPV changes as the discount rate used changes. Free to share, print, make copies and changes. Get yours at Wikipedia. "Internal rate of return." Public domain View on Boundless.comPublic domainhttp://en.wikipedia.org/wiki/Internal_rate_of_returnView on Boundless.com Capital Budgeting
Net Present Value (NPV) Formula NPV is the sum of of the present values of all cash flows associated with a project. The business will receive regular payments, represented by variable R, for a period of time. This period of time is expressed in variable t. The payments are discounted using a selected interest rate, signified by the i variable. Free to share, print, make copies and changes. Get yours at Wikipedia. "Net present value." GNU FDL View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Net_present_valueView on Boundless.com Capital Budgeting
Airplane Before purchasing a new airplane, airlines evaluate the NPV of the plan by calculating the PV of the revenue it can earn from it and the PV of its cost (e.g., purchase cost, maintenance, fuel, etc. ). Free to share, print, make copies and changes. Get yours at Viewology. "Pictures: AirAsia 9M-AFY Airbus A Airplane Arriving/Departing at Penang Airport – Viewology.Net." CC BY-SA airasia-9m-afy-airbus-a airplane-arrivingdeparting-at-penang-airport/768/ View on Boundless.comCC BY-SAhttp://viewology.net/pictures- airasia-9m-afy-airbus-a airplane-arrivingdeparting-at-penang-airport/768/View on Boundless.com Capital Budgeting
Medicine Drug developers must try to calculate the future revenues of a drug in order to find the NPV to determine if it is worth the cost of development. Free to share, print, make copies and changes. Get yours at Flickr. "Pills.| Flickr - Photo Sharing!." CC BY View on Boundless.comCC on Boundless.com Capital Budgeting
Machinery Being able to accurately find the NPV of a piece of machinery means having a good idea when all costs are going to occur (when it will need fixing) and when it will generate revenue (when it will be used on a job). Free to share, print, make copies and changes. Get yours at Fotopedia. "Liebherr R 317 by Alexandre Prévot in Heavy equipment, Hydraulic machinery, Liebherr Group on Fotopedia - Images for Humanity." CC BY-SA View on Boundless.comCC BY-SA on Boundless.com Capital Budgeting
NPV Decision Table NPV simply and clearly shows whether a project adds value to the firm or not. It's easy of use in decision making is one of its advantages. Free to share, print, make copies and changes. Get yours at Wikipedia. "Net present value." GNU FDL View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Net_present_valueView on Boundless.com Capital Budgeting
Free to share, print, make copies and changes. Get yours at Capital Budgeting Which of the following is a correct definition of Net Present Value. A) The sum of the present values of all a project's revenues and expenses. B) All of these answers. C) NPV = PVinflows + PVoutflows D) A means of evaluating a project's profitability.
Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Capital Budgeting Which of the following is a correct definition of Net Present Value. A) The sum of the present values of all a project's revenues and expenses. B) All of these answers. C) NPV = PVinflows + PVoutflows D) A means of evaluating a project's profitability.
Free to share, print, make copies and changes. Get yours at Capital Budgeting When evaluating the cash flows from a project, a financial manager needs to analyze the: A) costs, benefits, and opportunity costs of the project. B) The costs of the project C) The benefits of the project D) The costs and benefits of the project
Free to share, print, make copies and changes. Get yours at Saylor OER. "Business Administration « Saylor.org – Free Online Courses Built by Professors." CC BY BY Capital Budgeting When evaluating the cash flows from a project, a financial manager needs to analyze the: A) costs, benefits, and opportunity costs of the project. B) The costs of the project C) The benefits of the project D) The costs and benefits of the project
Free to share, print, make copies and changes. Get yours at Capital Budgeting The net present value can be: A) Positive, Zero, or Negative B) Positive C) Negative D) Zero
Free to share, print, make copies and changes. Get yours at Saylor OER. "Business Administration « Saylor.org – Free Online Courses Built by Professors." CC BY BY Capital Budgeting The net present value can be: A) Positive, Zero, or Negative B) Positive C) Negative D) Zero
Free to share, print, make copies and changes. Get yours at Capital Budgeting A company is considering a project that has a discount rate of 5%. In the first year, it will have -$100,000 in cash flows. In year 2, it will have cash flows of $100,000, and in year 3 the project will generate $200,000. What is the project's NPV? A) $358,708 B) $190,476 C) $193,204 D) $168,232
Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Capital Budgeting A company is considering a project that has a discount rate of 5%. In the first year, it will have -$100,000 in cash flows. In year 2, it will have cash flows of $100,000, and in year 3 the project will generate $200,000. What is the project's NPV? A) $358,708 B) $190,476 C) $193,204 D) $168,232
Free to share, print, make copies and changes. Get yours at Capital Budgeting The sum of cash revenues and expenditures over a period of time. A) Cash B) Assets C) Account Receivables D) Cash Flow
Free to share, print, make copies and changes. Get yours at Boundless Learning. "Boundless." CC BY-SA BY-SA 3.0http:// Capital Budgeting The sum of cash revenues and expenditures over a period of time. A) Cash B) Assets C) Account Receivables D) Cash Flow
Free to share, print, make copies and changes. Get yours at Capital Budgeting Under the present value concept, a lottery winner would rather receive: A) $10,000 per year for the next 5 years than receive $50,000 today. B) $10,000 per year for the next 5 years than receive $40,000 today. C) None of these, as the best answer depends on the interest rate that the lottery winner faces. D) $10,000 per year for the next 5 years than receive $30,000 today.
Free to share, print, make copies and changes. Get yours at Saylor OER. "Business Administration « Saylor.org – Free Online Courses Built by Professors." CC BY BY 3.0http:// Capital Budgeting Under the present value concept, a lottery winner would rather receive: A) $10,000 per year for the next 5 years than receive $50,000 today. B) $10,000 per year for the next 5 years than receive $40,000 today. C) None of these, as the best answer depends on the interest rate that the lottery winner faces. D) $10,000 per year for the next 5 years than receive $30,000 today.
Free to share, print, make copies and changes. Get yours at Capital Budgeting Each choice listed below represents a net present value of a potential project. If you were a CFO of a company which project would you choose? A) NPV = $500,000 B) NPV = $200,000 C) NPV = $0 D) NPV = -$100,000
Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Capital Budgeting Each choice listed below represents a net present value of a potential project. If you were a CFO of a company which project would you choose? A) NPV = $500,000 B) NPV = $200,000 C) NPV = $0 D) NPV = -$100,000
Free to share, print, make copies and changes. Get yours at Capital Budgeting Which of the following is an advantage of using the NPV method to evaluate different projects? A) All of these answers. B) It allows for easy comparisons of potential investments. C) NPV can be customized to reflect the financial concerns and demands of the company. D) NPV converts future revenue to current dollars, allowing the company to quantify a project's value.
Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Capital Budgeting Which of the following is an advantage of using the NPV method to evaluate different projects? A) All of these answers. B) It allows for easy comparisons of potential investments. C) NPV can be customized to reflect the financial concerns and demands of the company. D) NPV converts future revenue to current dollars, allowing the company to quantify a project's value.
Free to share, print, make copies and changes. Get yours at Capital Budgeting Which of the following is NOT included in calculating a project's NPV? A) All of these answers. B) The project's opportunity cost. C) The exact discount rate. D) The exact amounts of cash flow related to the project.
Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Capital Budgeting Which of the following is NOT included in calculating a project's NPV? A) All of these answers. B) The project's opportunity cost. C) The exact discount rate. D) The exact amounts of cash flow related to the project.
Free to share, print, make copies and changes. Get yours at Capital Budgeting Which of the following reasons is a reason why a higher discount rate generally means a lower NPV? A) Most projects do not pay off until years later, and those cash flows are highly discounted. B) A higher discount rate emphasizes earlier cash flows, which is when the expenses are incurred. C) All of these answers. D) When the discount rate is large, there are larger differences between PV and FV for each cash flow.
Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Capital Budgeting Which of the following reasons is a reason why a higher discount rate generally means a lower NPV? A) Most projects do not pay off until years later, and those cash flows are highly discounted. B) A higher discount rate emphasizes earlier cash flows, which is when the expenses are incurred. C) All of these answers. D) When the discount rate is large, there are larger differences between PV and FV for each cash flow.
Attribution Wikibooks. "Principles of Finance/Section 1/Chapter 2/Time Value of Money/PV and NPV." CC BY-SA ansCC BY-SA ans Wikipedia. "Net present value." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Net_present_value Wikispaces. "SU3FINANCE - Chapter 4 - NPV and the Time Value of Money." CC BY-SA BY-SA Boundless Learning. "Boundless." CC BY-SA BY-SA 3.0http:// Boundless Learning. "Boundless." CC BY-SA BY-SA 3.0http:// Wikibooks. "Principles of Finance/Section 1/Chapter 2/Time Value of Money/PV and NPV." CC BY-SA ansCC BY-SA ans Wikipedia. "Net present value." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Net_present_value Wikispaces. "SU3FINANCE - Chapter 4 - NPV and the Time Value of Money." CC BY-SA BY-SA Wiktionary. "cash flow." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/cash+flow Wiktionary. "variable." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/variable Wiktionary. "discount rate." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/discount+rate Wikibooks. "Principles of Finance/Section 1/Chapter 2/Time Value of Money/PV and NPV." CC BY-SA ansCC BY-SA ans Wikipedia. "Net present value." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Net_present_value Wikispaces. "BUS304-PrinciplesofFinance - Chapter 7." CC BY-SA principlesoffinance.wikispaces.com/Chapter+7CC BY-SAhttp://bus304- principlesoffinance.wikispaces.com/Chapter+7 Wikispaces. "SU3FINANCE - Chapter 4 - NPV and the Time Value of Money." CC BY-SA BY-SA Wikispaces. "SU3FINANCE - Chapter 7 - Investment Decision Rules." CC BY-SA BY-SA Wikipedia. "internal rate of return." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/internal%20rate%20of%20return Free to share, print, make copies and changes. Get yours at Capital Budgeting
Wiktionary. "discount rate." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/discount+rate Wikibooks. "Principles of Finance/Section 1/Chapter 2/Time Value of Money/PV and NPV." CC BY-SA ansCC BY-SA ans Wikipedia. "Net present value." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Net_present_value Wikispaces. "SU3FINANCE - Chapter 4 - NPV and the Time Value of Money." CC BY-SA BY-SA Boundless Learning. "Boundless." CC BY-SA BY-SA 3.0http:// Wikibooks. "Principles of Finance/Section 1/Chapter 2/Time Value of Money/PV and NPV." CC BY-SA ansCC BY-SA ans Wikipedia. "Net present value." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Net_present_value Wikispaces. "SU3FINANCE - Chapter 4 - NPV and the Time Value of Money." CC BY-SA BY-SA Wiktionary. "Opportunity cost." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/Opportunity+cost Wikispaces. "SU3FINANCE - Chapter 4 - NPV and the Time Value of Money." CC BY-SA BY-SA Wikipedia. "Net present value." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Net_present_value Wikibooks. "Principles of Finance/Section 1/Chapter 2/Time Value of Money/PV and NPV." CC BY-SA ansCC BY-SA ans Wiktionary. "cash flow." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/cash+flow Free to share, print, make copies and changes. Get yours at Capital Budgeting