Net Present Value (NPV) of a project is the sum of the present value of all its cash outflows and inflows. When this value is positive, it indicates that the project would add value to the organization and hence should be accepted. On the other hand, if the NPV of the project is negative, the project should be rejected. N P V = − C F 0 ^ + C F ^ 1 ( 1 + r ) 1 + C F ^ 2 ( 1 + r ) 2 + ....... + C F n ^ ( 1 + r ) n = ∑ t = 0 n C F t ^ ( 1 + r ) t Here, Expected net cash flow in Period t is “ C F t ^ ” Required rate of return is “ r ” NPV profile of a project is created by first determining the NPV of the project at varying discount rate and then plotting the same. The point when the graph crosses the X-axis is the Internal rate of Return (IRR) of the project, as IRR of a project is the required rate at which the NPV is zero. It helps in determining which project is more sensitive to the changes in the discount rate by analysing the steepness of the project. A capital budgeting project has an initial cost of $64,000 which is expected to generate $18,200 for five years. Discount rates are 10%, 13% 15%.

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Chapter 9, Problem 9PROB

Summary Introduction

Net Present Value (NPV) of a project is the sum of the present value of all its cash outflows and inflows. When this value is positive, it indicates that the project would add value to the organization and hence should be accepted. On the other hand, if the NPV of the project is negative, the project should be rejected.

NPV=−CF0^+CF^1(1+r)1+CF^2(1+r)2+.......+CFn^(1+r)n=∑t=0nCFt^(1+r)t

Here,

Expected net cash flow in Period t is “CFt^”

Required rate of return is “r”

NPV profile of a project is created by first determining the NPV of the project at varying discount rate and then plotting the same. The point when the graph crosses the X-axis is the Internal rate of Return (IRR) of the project, as IRR of a project is the required rate at which the NPV is zero. It helps in determining which project is more sensitive to the changes in the discount rate by analysing the steepness of the project.

A capital budgeting project has an initial cost of $64,000 which is expected to generate $18,200 for five years. Discount rates are 10%, 13% 15%.

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