Explain net present value method, Financial Management

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Q. Explain Net Present Value Method?

Net Present Value (NPV) Method: - This process measures the Present value of returns per rupee invested. In this method present value of Institute of IT & Management cash outflows and cash inflows is computed and the present value of cash outflow is subtracted from the present value of cash inflows. The difference is described as NPV.

NPV= PV of Inflow - PV of Outflow

NPV = [(Cash inflow in 1^st year x PVF ¹) + (Cash inflow in 2^nd year x PVF ²) + (Cash

inflow in 3rdyear x PVF ³) +-----------(Cash inflow in nth year XPVFn)] - [Initial cash outflow X PVF ⁰]

PVF¹ = Present Value Factor in 1^st year

PVF² = Present value factor in 2^nd year and so on.

If PVF is not given, we may calculate NPV as follows:

NPV = [Cash inflow in 1^st year X 1/(1+r)¹ ] + [Cash inflow in 2^nd year X 1/(1+r) ²] +

[Cash inflow in 3^rd year X 1/(1+r)³ ] +--------[Cash inflow in n^th year X 1/(1+r)ⁿ ] - [Initial Cash outflow X 1/(1+r)⁰]

Accept-Reject Criteria:-

If NPV is positive the project possibly accepted
If NPV is negative the project mayn't be accepted.
If NPV is zero the project may be accepted merely if non-financial benefits are there.

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