Finance - NPV

Question 1

Explain what net present value is and the steps to calculate NPV

Answer 1

NPV - is a quantitative model used to support decision-making in a situation where cash flow occurs over different time periods

NPV : 1. Identify relevant cash flows and expected timing
2. Determine the appropriate discount rate
3. Calculate the PV of individual cash flow and NPV

Question 2

What are the relevant factors to determine what is to be included in the cash flow

Answer 2

• Relevant cash flow - The cash inflow and outflows that differ between alternative and specific to this analysis

Question 3

What is used to determine the appropriate discount rate? Also, what is the formula used for future discount rate

Answer 3

• The discount rate reflects the time value of money for risk of investment

NPV = CF0 / (1+r)^0 + CF1 / (1+r)^1 + CF2 / (1+r)^2 = CFn / (1+r)^n

CF= Cash flows occurring at the end of the period
t= (0,1,2). Inflow positive sign, outflow (-) sign
r= discount rate
PVIF = Present value interest factor = 1/ (1+r)^n

Question 4

Does NPV have the same or inverse relationship to the discount rate?

Answer 4

NPV has an inverse relationship with the discount rate.
If the discount rate increases, NPV decreases and vice-verse