Lecture 7: Investment Decisions 1, Net Present value approach Flashcards
What is NPV
Present value (PV): The value of the assets (cash flows) now
Future value (FV): the value of the assets (cash flows) on a specific date in the future
PV= FV/(1+R) T and FV = PV * (1+R) T
Where R is the discount rate, T is the number of period, PV is the present value of the cash flow and FV is the future value of the cash flow.
Net present value (NVP) is simply the sum of present values of all cash flows (including the one occurring at time 0)
The general formula of NPV: Check page 53
Where CF is the cash flow occurring at time point t and R is the required rate of return (or interest rate or cost of capital or discount rate…)
Then what is the present value of a series of cash flows?
o In this case, you can take this series of cash flows as a special case of an annuity.
o For a conventional annuity, we start receiving annual payments in one year and the annual payments are identical
o For this special case, there is a cash flow occurs at the beginning (time point 0), and the annual cash flows may not be identical.
o The present value of this special case is called the net present value (NPV)
o In other words, net present value (NPV) is the difference between the present value of cash inflows (i.e., periodic income received from a project) and the present value of cash outflows (i.e., initial investment of a project) over a period of time.
o The NPV of a project is the sum of present values of all future cash flows and deduct the initial outlay.
o NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.
