The document discusses Net Present Value (NPV) as a capital budgeting decision tool. It provides an example to illustrate NPV calculation. The key points are: 1) NPV is defined as the present value of the cash flows from an investment minus the initial investment cost. 2) In the example, constructing a building with $400,000 certain sale price in a year has an NPV of $23,832 when the land costs $50,000, construction costs $300,000, and the discount rate is 7%. 3) Projects with positive NPV should be accepted as they are expected to increase firm value and owner wealth. NPV directly measures how well a project meets the

2. Net Present Value
MUHAMMAD IRFAN
Assistant Professor, Sarhad University, Peshawar.

3. NET PRESENT VALUE (NPV)
Capital Budgeting Decision
 For the success of any company, the investment
decision is very important, which is also known as
the capital budgeting decision.
 Assets acquired as a result of the capital budgeting
decision can determine the success of the business for
many years.
 So, It is extremely important to ensure that the correct
capital budgeting decision is made….

4. NET PRESENT VALUE
 Capital Budgeting Decision
 Suppose you had the opportunity to buy a Tbill
(Treasury Bill) which would be worth $400,000
one year from today.
 Interest rates on Tbills are a risk free 7%.
 What would you be willing to pay for this
investment?
$400,000 / (1.07) = $373,832
PV today:
0 1 2
-$400,000

5. NET PRESENT VALUE
 Capital Budgeting Decision
 You would be willing to pay $373,382 for a risk free
$400,000 a year from today.
 Suppose this were, instead, an opportunity to construct a
building, which you could sell in a year for $400,000 with
certainty (That means the project is risk free.)
 Since this investment has the same risk and promises
the same cash flows as the Tbill, it is also worth the same
amount to you:
$373,282

6. NET PRESENT VALUE
 Capital Budgeting Decision
 Now, assume you could buy the land for $50,000
and construct the building for $300,000. Is this a
good deal?
 Sure! If you would be willing to pay $373,382 for
this investment and can acquire it for only
$350,000, you have found a very good deal!
 You are better off by:
$373,382 - $350,000 = $23,832

7. NET PRESENT VALUE
For this Purpose,,,
 A good way of evaluating an investment decision
is used that is known as Net Present Value
(NPV).
 NPV is defined as the PV of the cash flows from
an investment minus the initial investment.
NPV = PV – Required Investment (C0)
= [$400,000/(1+.07)] - $350,000
= $23,832

8. NET PRESENT VALUE…
 The difference between the market value of a project
and its cost.
 The difference between the present value of cash
inflow and the present value of cash outflow.
 Discounted Cash Flow (DCF) Valuation:
 The first step is to estimate the expected future cash flows.
 The second step is to estimate the required return for
projects of this risk level.
 The third step is to find the present value of the cash flows
and subtract the initial investment.

9. NPV
 NPV = PV of cash inflow – PV of cash outflow.
 NPV is a standard method for financial appraisal
of long term project.
 It is the present value of net cash flow.
 It is used for two reasons normally,
 Assessing the Value of Project.
 Choose which project has priority.

10. NPV…
 If the NPV is positive, accept the project
 A positive NPV means that the project is expected to
add value to the firm and will therefore increase the
wealth of the owners.
 Since our goal is to increase owner wealth, NPV is a
direct measure of how well this project will meet our
goal.
 Decision Criteria:
 If NPV > or equal to 0 ……. Accept
 If NPV < 0 ………………… Reject

11. Semih Yildirim ADMS 3530
NET PRESENT VALUE
Simply discount the cash flows at the appropriate opportunity cost
of capital and then subtract the cost of the initial investment.
 The critical problems in any NPV problem are to determine:
 The amount and timing of the cash flows.
 The appropriate discount rate.
NPV Rule: Accept Projects with Positive NPVs

12. NET PRESENT VALUE

13. Thank You…