Question

If you were to start your own business (please state what business), how might you use Net Present Value to help you make a decision if this project is worthwhile. What numbers/inputs would you require to determine the NPV? TO RESPOND TO THIS QUESTION IF MY CHOICE OF THE BUSINESS IS REAL ESTATE. HOW CAN I RESPOND TO THESE QUESTION?

Answer 1

Net present value is a widely used concept in capital budgeting where by the cash inflows of a business are compared to the cash outflows. It accounts for the fact that the present worth of future cash flows can be invested to earn a certain rate of return. Net present value is the difference between the sum of discounted cash inflows and the initial investment required for the investment.

In case of a real estate business all the initial costs of the business such as the cost of the office the cost of material required for a real estate project and any other initial investment should be accounted for. The cash inflows every year would comprise of revenue generated from the sale of the real estate and the operating costs of the business would be the cash outflows. The business needs to calculate its cost of capital which will be used as the discount factor for evaluating the net present value of the business. If the npv is positive the business is considered profitable else the business should not be undertaken.