MADE BY TOOBA FATIMA

PRESENT VALUE &NET PRESENT VALUE

CASH INFLOW

CASH OUTFLOW

Cash inflow refers to a business or company's sources of money or income

Cash outflow refers to a business or company's expenses

NET PRESENT VALUENet present value method (also known as discounted cash flow method) is a popular capital budgeting technique that takes into account the time value of money.

NET PRESENT VALUENet present value is the difference between the present value of cash inflows and the present value of cash outflows that occur as a result of undertaking an investment project.

It may be positive, zero or negative.

POSITIVE NPVIf present value of cash inflows is greater than the present value of the cash outflows, the net present value is said to be positive and the investment proposal is considered to be acceptable.

NEGATIVE NPVIf present value of cash inflow is less than present value of cash outflow, the net present value is said to be negative and the investment proposal is rejected.

ZERO NPVIf present value of cash inflow is equal to present value of cash outflow, the net present value is said to be zero and the investment proposal is considered to be acceptable.

POSITIVE, NEGATIVE AND ZERO NPV

RATE OF RETURNA rate of return is the gain or loss on an investment over a specified time period, expressed as a percentage of the investment's cost.

ILLUSTRATIONAssume a company is planning to invest $9000 in a project today.

The project is expected to have a life of four years.

The expected cash flows at the end of each of the next four years are $2000, $3000, $3000 & $4000.

$9000

$2000 $3000 $3000 $400010%

3 year2 year1 year 4year

$9000

$2000 $3000 $3000 $400010%

3 year2 year1 year 4year

FV=PV(1+r)n or PV=FV/(1+r)n

$9000

$2000 $3000 $3000 $400010%

3 year2 year1 year 4year

FV=PV(1+r)n or PV=FV/(1+r) n

PV=$2000/(1+0.10) 1 = $1818.18

$9000

$2000 $3000 $3000 $400010%

3 year2 year1 year 4year

FV=PV(1+r)n or PV=FV/(1+r) n

PV=$3000/(1+0.10) 2 = 2479.34

$9000

$2000 $3000 $3000 $400010%

3 year2 year1 year 4year

FV=PV(1+r)n or PV=FV/(1+r) n

PV=$3000/(1+0.10) 3 = $2253.94

$9000

$2000 $3000 $3000 $400010%

3 year2 year1 year 4year

FV=PV(1+r)n or PV=FV/(1+r) n

PV=$4000/(1+0.10) 4 = $2732.05

PV0=-9000

PV1=1818.18

PV2=2479.34

PV3=2253.94

PV4=2732.05

NPV=$283.51

Determine NPV

NPV is Positive

CONCLUSION A Positive NPV means the combined PV of all cash inflows exceeds the PV of cash outflows.

In our Example the NPV of $283.51 suggests that the combined PV of all cash inflows exceeds the PV of cash outflows by $283.51

This project is an acceptable one since it adds $283.51 to the value of the company.