Net Present Value
The net present value of a time series of cash flows, both incoming and outgoing is defined as the aggregate of the present values (PVs) of the individual cash flows of the same entity. It is also known as Net Present Value.
When all future cash flows are incoming for instance coupons and principal of a bond. The only outflow of cash is the purchase price, the in that case, the Net Present Value is merely the present value(PV) of future cash flows deducting the purchase price (which is its own present value). Net Present Value is a central tool in discounted cash flow (DCF) analysis. It is a standard method for employing the time value of money to evaluate long-term projects. It can be employed widely throughout economics, finance, accounting and capital budgeting. Once financing charges are fulfilled, it evaluates the shortage or excess of cash flows in the terms of present value.
The Net Present Value of successive cash flows takes the cash flows as input and a discount rate/ discount curve and yields a price. The reversed process in DCF analysis is as input accepting a sequence of cash flows and a price and as output inferring a discount rate > The discount rate which would bring about the given price as Net Present Value is known as the yield. This term is widely employed in bond trading.
Net Present Value is an indicator of value an investment that project adds to the firm. With a peculiar project:
> If Rt is a positive value, then the project is in the condition of positive cash inflow in the time of t.
> If Rt is a negative value, then the project is in the condition of discounted cash outflow in the time of t.
In an particular manner, risked projects with a positive Net Present Value could be accepted. This does not mean that they should be accepted as a challenge since Net Present Value at the cost of capital may not describe for opportunity cost, i.e. comparing with other investments.
In finance, if there is a choice between two mutually exclusive options, the one yielding the higher net present value should be picked out.
> If Net Present Value > 0, it means that the investment would add value to the firm, then there are higher chances that the project may be accepted.
> If Net Present Value = 0, it means that the investment would neither gain nor lose value for the firm. In such case it should be indifferent in the decisiveness whether to reject or accept the project. This project contributes no monetary value. The decision should be grounded on other criteria such as strategic positioning or other factors not permit an explicit manner in the computation.
> If Net Present Value < 0, it means that the investment would subtract value from the firm. Then in that case, the project should be rejected.
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