Net Present Value (NPV) is the difference between total present value of cash inflows and outflows. It iswidely used method for evaluating the desirability of the project as it considers the time value of money as well as timing of the cash flows (Moyer, McGuigan, Rao, & Kretlow, 2012).

Calculation of NPV

For the calculation of NPV, let us assume that the initial investment is Rs. 2,000,000 and the discount rate is 20%. In addition, the cash flows are uneven and no additional investments are made in following years.

Year

Cash flow (CF)

PV Factor @ 20%

Discounted CF

1

800,000

0.8333

666,640

2

700,000

0.6944

486,080

3

650,000

0.5787

376,155

4

600,000

0.4823

289,380

5

800,000

0.4019

321,520

Total

2,139,775

Less: Initial Investment

2,000,000

NPV

139,775

If we increase the discount rate to 25% keeping the cash flows and time horizon constant, the NPV will be:

Year

Cash flow (CF)

PV Factor @ 25%

Discounted CF

1

800,000

0.8000

640,000

2

700,000

0.6400

448,000

3

650,000

0.5120

332,800

4

600,000

0.4096

245,760

5

800,000

0.3277

262,160

Total

1,928,720

Less: Initial Investment

2,000,000

NPV

-71,280

From the two different cases, we can see that the increase in discount rate leads to decrease in NPV of a project keeping other variables constant. In case of independent projects, the projects with positive NPV are accepted and project with highest NPV among the given alternatives is selected if the projects are mutually exclusive. Thus the projects with lower discount rate are more likely to be accepted as it results in higher NPV.

References
Moyer, R. C., McGuigan, J. R., Rao, R., & Kretlow, W. J. (2012). Contemporary Financial Management (12th ed.). Oklahoma: Cengage Learning.

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Net Present Value (NPV) is the difference between total present value of cash inflows and outflows. It iswidely used method for evaluating the desirability of the project as it considers the time value of money as well as timing of the cash flows (Moyer, McGuigan, Rao, & Kretlow, 2012).

Calculation of NPVFor the calculation of NPV, let us assume that the initial investment is Rs. 2,000,000 and the discount rate is 20%. In addition, the cash flows are uneven and no additional investments are made in following years.

If we increase the discount rate to 25% keeping the cash flows and time horizon constant, the NPV will be:

From the two different cases, we can see that the increase in discount rate leads to decrease in NPV of a project keeping other variables constant. In case of independent projects, the projects with positive NPV are accepted and project with highest NPV among the given alternatives is selected if the projects are mutually exclusive. Thus the projects with lower discount rate are more likely to be accepted as it results in higher NPV.

ReferencesMoyer, R. C., McGuigan, J. R., Rao, R., & Kretlow, W. J. (2012). Contemporary Financial Management (12th ed.). Oklahoma: Cengage Learning.