What does a net present value profile tell you, and how is it constructed? How does...

What does a net present value profile tell you, and how is it constructed? How does the IRR enter into the net present value profile?

Expert Solution

Net present value refers to the present value of all the future cash flows that a prticular investment or the project is going to generate less the initial investment, it is discounted by the discount rate which is generally the cost of capital or the minimum return of the project that the firm needs.

The NPV profile refers to the calculation of the Net present value using different Discount rate not just one discount rate and the NPV value is observed at those rates and then the discount rate is identified at which the Net present value of the project is Zero which is the point known as the internal rate of return.

The IRR shows that the average rate of return of the project gives over the lifetime and it is the point where the net present value is Zero. If the IRR is more than the cost of the capital then the project should be selected and vice-versa as it shows whether the firm is giving minimum or desirable rate of return or not.

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