Question

The net present value of an investment is best defined as the

1 current cost if the investment is made today.

2 net value received at the end of the investment period.

3 present value of the investment's future cash flows minus the investment's cost.

4 net decrease in value caused by waiting to receive the cash benefit from the investment.

5 value received at the end of the investment period minus the investment's cost.

Answer 1

Net present value is nothing but a tool of capital budgeting to decide whether an investment or project is profitable or not.

It is the difference between the present value of cash inflows and present value of cash outflows over a period of time discounted at a specified rate.

The formula of NPV is given by:

NPV = cash inflows/(1+r)^n - Initial investment

Cash inflows = cash flow in the time period

r = discounting rate

n = time period

NPV simply means the time value of money. It means a rupee today is of more value today than it will be tomorrow.

After discounting the cash flows over a period of time, the investment cost or initial cost is deducted from it.

• If the value of NPV is positive - the project is viable.
• If the value of NPV is negative - the project is rejected.
• If the value of NPV is zero - the project is at indifferent point.

Hence as per the above explanations, the answer to the given question is 3 i.e. present value of investment's future cash flows minus investment's cost.