2. PROJECT SUBMITTED TO :-
JAGRUTI MAM
PROJECT SUMITTED BY :-
BHAVESH HATHIWALA (37)
BHAVESH JAIN (38)
PROJECT TOPIC :-
NET PRESENT VALUE METHOD (NPV)
3. NET PRESENT VALUE METHOD
(NPV)
The net present value criterion is based on the economic
reasoning of discounting future cash flow to make them
comparable. It takes into account the opportunity cost of
investment. Thus, the Net present value method of project
evaluation involves comparing the present values of all net
cash inflows to the initial investment cost.
The Net present value of the project is calculated by discounting
all future flows to the present and deducting the present value
of all outflows from the present value of gross earning over the
life span of the asset.
4. The decision rule of the net present value method, therefore may be stated as follows :
• Project is to be accepted if its net present value is positive.
• Project is to be rejected if its net present value is negative.
• If the net present value of the project is zero. It is a case of indifference towards
the project.
The formula for net present value is :-
Net present value = A1 + A2 + A3 + ……………….. An - CO
(1+r) (1+r) 2 (1+r) 3 (1+r)n
Here ,
(i) A1, A2,A3 show the net cash flows over a number of years of the life period
of a project.
(ii) R2 is the rate of discount
(iii) Co is the cost of project , it represent the net investment in the project
inclusive of initial cost.
(iv) n is the number of years.
5. Example :- we assume that a firm is considering to purchase a machine today at
a cost of Rs. 5o,ooo /-. The use of this machine in the production process of an
article leads to an increase in its revenue by Rs. 30,000/- in each of the next two
years. The rate of interest is assumed at 10 percent per annum and the machine
has no scrap value. Would the firm invest in this machine?
ANS :- NET PRESENT VALUE = A1 + A2 - Co
(1+r) (1+r)2
= 30000 + 30000 - 50000
(1+10) (1+10)2
100 100
= 30000*100 + 30000*100 - 50000
11 121
= 272727.27+24793.38-50000
= 297520.65-50000
= 247520.65.
“so, the net present value of the machine is positive and therefore the firm would
make investment in it.
6. MERITS
(i) This method takes into account the time value of money.
(ii) It considers the cash flow stream in its entirety.
(iii) In all those cases , whenever a decision about a package of
projects is to be taken, this method ensures that which individual
project is worthwhile.
(iv) According to “Hawkins & Pearce”, this method is theoretically
found to be superior, because when the firm aims at profit
maximisation the use of this method greatly helps in arriving at a
correct decision.
(v) This method is simple to understand, easy to calculate and
serves as a guide in accepting or rejecting a project.
7. DEMERITS
(i) It involves considerable amount of calculations and as such it is
not easy to comprehend and apply like the traditional methods of
investing evaluation.
(ii) Again, the determination of an appropriate discount rate in itself
is a difficult task.
(iii) In view of substantial difference in time – span (present and
future) and the risk involved in various capital projects.
