Question

19. What is the NPV of the project? Which you accept the project?

Answer 1

Net Present Value (NPV) of a project is sum of all cash flows of the project discounted at the required rate of return. Required rate of return is rate of return we can generate by investing the money in alternative assets.

For example, if our initial investment(Cash outflow at year 0) is $100,000, yearly cash inflow from the project is $30,000 for 5 years and required rate of return is 12%. Then NPV is calculated as follows-

	0	1	2	3	4	5
Cash Outflow (Given in negative since it is outflow)	(100,000)
Cash inflow		30,000	30,000	30,000	30,000	30,000
Discounting Factor at Required Rate of return@12%	1	0.8929	0.7972	0.7118	0.6355	0.5674
[1/{(1+0.12)^n}]
Where, n is the number of year
Discounted Cash Flows (Cash flows*disounting factor)	(100,000)	26,786	23,916	21,353	19,066	17,023

Hence NPV = (100,000) + 26,786 +23,916+21,353+21,353+19,066+17,023 = 8,143

When a NPV of a project is positive, we should accept the project since we are getting more than the investment (cash inflow is more than Cash outflow ).

In the example, we have positive cash flow, we should accept the project.

If NPV of a project is negative, we should reject the project.