How should NPV be calculated?
NPV = present value of cash inflows - present value of cash outflows.
The above formula is based on net cash flow = cash inflow - cash outflow, evolved. In general, the investment in a project is relatively long; in order to calculate accurately, the time value of money needs to be considered. Therefore, cash inflows, cash outflows need to calculate the present value separately. That is, net present value = present value of cash inflows - present value of cash outflows. The net present value is generally expressed as NPV.
What are the criteria for determining NPV?
Determination criteria 1: If NPV ≥ 0, the investment program is feasible.
NPV greater than 0 is equivalent to a gain, the investment program is feasible; NPV is equal to 0, meaning that the present value of cash inflows is equal to the present value of cash outflows, at this time neither profit nor loss, the investment program is also feasible.
Determination criteria 2: If NPV
0, the investment program is not feasible.
The present value of inflows is smaller than the present value of outflows, which means that money is lost, and the program is not feasible.
Determination Criterion 3: Other things being equal, the greater the NPV, the better the program.
As an example, investment project one and investment project two both require an investment of one million dollars. Assuming an infinite investment time, the NPV of project one is $4 million and the NPV of project two is $6 million, at which point the choice is to select project two.
Determination Criterion 4: The higher the cost of capital of the firm, the lower the NPV.
Cost of capital is the cost of capital rate. The higher the cost of capital rate, means the higher the price paid for financing, which can be understood here as a high annual cost of cash payments. A high cost of paying cash, with constant revenues, corresponds to less net outflows per year, implying a decrease in present value. With constant outflows, the net present value is also less.
What are the factors that affect NPV?
Factors that affect NPV include cash outflows, cash inflows, and the discount rate.