Net Present Value (NPV): Difference between revisions

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== Abstract ==
== Abstract ==


The financial appraisal is a method used to evaluate whether a proposed project, program, or portfolio is worthwhile by considering the benefits and costs that result from its execution <ref name="Häcker" />. Investment decisions of the management are critical to a company since it decides the future of the company. This article discusses the '''net present value (NPV)''' method which is widely used in the financial appraisal. NPV is a dynamic financial appraisal method that considers the time value of money by applying discounting to all future payment series during the investment period <ref name="Häcker" />. In simple terms, the NPV is the difference between the project's future incoming and outgoing cash flows at present time. The calculation of the NPV starts by determining the net cash flows from the difference of future incoming cash flows and outgoing cash flows for each period of an investment. After the net cash flow for each period is calculated, the present value (PV) of each one is achieved by discounting using a suitable discount rate. NPV is the cumulative value of all the discounted future net cash flows <ref name="Häcker" /> <ref name="Ferrari" />.
The financial appraisal is a method used to evaluate whether a proposed project, program, or portfolio is worthwhile by considering the benefits and costs that result from its execution <ref name="Häcker" />. Investment decisions of the management are critical to a company since it decides the future of the company <ref name="LOCK">. This article discusses the '''net present value (NPV)''' method which is widely used in the financial appraisal. NPV is a dynamic financial appraisal method that considers the time value of money by applying discounting to all future payment series during the investment period <ref name="Häcker" />. In simple terms, the NPV is the difference between the project's future incoming and outgoing cash flows at present time. The calculation of the NPV starts by determining the net cash flows from the difference of future incoming cash flows and outgoing cash flows for each period of an investment. After the net cash flow for each period is calculated, the present value (PV) of each one is achieved by discounting using a suitable discount rate. NPV is the cumulative value of all the discounted future net cash flows <ref name="Häcker" /> <ref name="Ferrari" />.


Firstly, this article discusses the idea behind the NPV method. Then this introduces the NPV calculation method <ref name="Häcker" /> and describes the importance of choosing the suitable discount rate <ref name="Žižlavský" />. Also, it discusses the other NPV formula for special cases such as annuity and perpetuity. Then it highlights the decision criteria behind NPV and explains it with real-life applications. Finally, it critically reflects on the limitations <ref name="Bora" /> of this method and briefly highlights the key references used in this article.
Firstly, this article discusses the idea behind the NPV method. Then this introduces the NPV calculation method <ref name="Häcker" /> and describes the importance of choosing the suitable discount rate <ref name="Žižlavský" />. Also, it discusses the other NPV formula for special cases such as annuity and perpetuity. Then it highlights the decision criteria behind NPV and explains it with real-life applications. Finally, it critically reflects on the limitations <ref name="Bora" /> of this method and briefly highlights the key references used in this article.

Revision as of 22:41, 19 March 2022

Written by Deepthi Tharaka Parana Liyanage Don- s203116

Abstract

The financial appraisal is a method used to evaluate whether a proposed project, program, or portfolio is worthwhile by considering the benefits and costs that result from its execution [1]. Investment decisions of the management are critical to a company since it decides the future of the company Cite error: Closing </ref> missing for <ref> tag [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12]

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  1. ↑ Cite error: Invalid <ref> tag; no text was provided for refs named Häcker
  2. ↑ Ferrari, C., Bottasso, A., Conti, M. and Tei, A., Ch. 5 - Investment Appraisal. In: Economic role of transport infrastructure: Theory and models, (Elsevier, 2018), pp. 85-114, https://doi.org/10.1016/C2016-0-03558-1
  3. ↑ Konstantin P. and Konstantin M., Ch. 4 - Investment Appraisal Methods. In: Power and Energy Systems Engineering Economics, (Springer, Cham, 2018), pp. 39-64, https://doi.org/10.1007/978-3-319-72383-9_4
  4. ↑ Poggensee K. and Poggensee J., Ch. 3 - Dynamic Investment Calculation Methods. In: Investment Valuation and Appraisal, (Springer, Cham, 2021), pp. 85-140, https://doi.org/10.1007/978-3-030-62440-8
  5. ↑ Ing E. and Lester A., Ch. 5 - Business case and Ch. 6 - Investment Appraisal. In: Project Management, Planning and Control. 7th Edition, (Elsevier, 2017), pp. 25-36, https://doi.org/10.1016/B978-0-08-102020-3.00006-1
  6. ↑ Bora, B., Comparison between net present value and internal rate of return, International Journal of Research in Finance and Marketing, (2015), 5(12), pp.61-71
  7. ↑ LOCK, D., Project management. 10th edition, (Farnham, Surrey, England, Gower Pub., 2013).
  8. ↑ Žižlavský, O., Net present value approach: method for economic assessment of innovation projects. Procedia-Social and Behavioral Sciences, 19th International Scientific Conference, Economics and Management, 156 (2014), pp. 506-512.
  9. ↑ AXELOS, Managing Successful Projects with PRINCE2, 6th Edition, (The Stationery Office Ltd, 2017).
  10. ↑ AXELOS, and Office Cabinet., Managing Successful Programmes, 2011 Edition, (The Stationery Office Ltd, 2011).
  11. ↑ AXELOS, Office of Government Commerce, Kilford, C., Management of Portfolios, 2011 Edition, (The Stationery Office Ltd, 2011).
  12. ↑ International Organization for Standardization (ISO, 2021), Project, programme and portfolio management – Context and concepts (DS/ISO 21502:2021).
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