25 - decision rule says to invest in projects when the net...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
What does it mean if a project has an NPV of $1 million? Explain. In finance, the net present value (NPV) or net present worth (NPW) of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows of the same entity. In the case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow (DCF) analysis, and is a standard method for using the time value of money to appraise long-term projects. Calculating the net present value (NPV) of an investment project is relatively straightforward. First, write down the net cash flows that the investment will generate over its life. Second, discount these cash flows at an interest rate that reflects the degree of risk inherent in the project. The resulting sum of discounted cash flows equals the project’s net present value. The NPV
Background image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: decision rule says to invest in projects when the net present value is greater than zero. When a firm can find a project with a positive NPV, the project offers a return that exceeds shareholders expectations. A firm that consistently finds positive-NPV investments will consistently surpass shareholders expectations and will enjoy a rising stock price. Conversely, if the firm makes an investment with a negative NPV, the investment will disappoint shareholders (Nitzan, & Bichler, 2009). A firm that regularly makes negative-NPV investments will see its stock price lag as it persists in generating lower-than-required returns for stockholders. The net present value approach provides a direct estimate of the increase or decrease in shareholder value resulting from a particular investment. An NPV of $1 million means that $1 million in shareholder value (market capitalization) is being added to the firm....
View Full Document

Ask a homework question - tutors are online