Question

Explain how to calculate the NPV (net present value) of an alternative.

What is the decision rule for adopting a project?

Answer 1

With help of NPV we can get today's value of a future stream of payments

To get the NPV, first of all we  determine the current value for each year's return , after that we use the expected cash flow. After that we divide it by the discounted rate.

Decision rule for adopting a project can be given as following types.

During decision-making process, we use the net present value (npv) rule to decide whether to pursue a project or not.

If the calculated NPV of a project is negative i.e. less than zero (< 0), the project is expected to result in a net loss. In this case it is not preferable to pursue project.

If calculated NPV of project is positive (> 0) i.e. greater than zero then the company can expect a profit .in this case it is advised to moving forward.

If a project's NPV is neutral (= 0), the project is not expected to result in any significant gain or loss for the company.

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