NPV
Net Present Value (NPV) discounts the cash flow by the cost of capital The cost of capital includes interest foregone, inflation, the risk premium of the investment example
| Year 0 | (150) | 1 | (150) |
| Year 1 | 30 | 0.87 | 26 |
| Year 2 | 30 | 0.756 | 22.68 |
| NPV | (101.32) |
Good because it
- Includes all cash flows
- takes in to account the timing of cash flows
- looks at actual cask not a percentage unlike IRR
- Deals with risk
- Deals with Opportunity Costs
- Any positive NPV is accepted
Annuity Tables can only be used if the constant.
NPV2
Evaluation of projects with unequal lives
1 Lowest Common Multiple Method (LCM)
Extend the projects' life to the same number of years. For instance a 2 and 3 year project is extended 6 years and 2,3 and 4 year project is extended to 12 years using the normal NPV methods see NPV
- Good for comparing like for like for projects with different lives
- Cumbersome if LCM goes over 6 years
- No good if the life of the project is less then the LCM
2. Equivalent Annual Cash Flow
Divide the sum of the NPV's by the sum of the discount factors (annuity) So after 1 year is the NPV is 46 and DC is 0.885 = 51 After Year 2 sum of NPV is 45 plus 39 and the annuity is 0.885+0.783 = 50.3 The equilvalent annual cash flow for 1 is slightly higher
Estimate Terminal values Assumes that the project will end before the life of the asset. Add the terminal values to that year
See also Capital Rationing
