Chapter 3, Problem 1QPD

Does the NPV of future cash flows increase or decrease as the discount rate increases?

To determine

Explain whether the net present value increase or decrease if the discount rate increases.

Explanation of Solution

Net present value (NPV): Net present value is used to compare the initial cash outflow of the investment with the present value of its cash inflows. The net present value is calculated as below:

$\text{Net present value = Present value of cash inflows}–\text{Initial cash outflows}$

The NPV of future cash flows decreases if the discount rate increases.