The Npv Rule Is the Best Investment Appraisal Method
Investment decisions are essential for a business as they define the future survival, and growth of the organisation. The main objective of a business being the maximisation of shareholders' wealth. Therefore a firm needs to invest in every project that is worth more than the costs. The Net Present value is the difference between the project's value and its costs. Thus to make shareholders happy, a firm must invest in projects with positive NPVs. We shall start this essay with an explanation of the NPV, then compare this method with other investment appraisal methods and finally try to define, based on the works of Tony Davies, Brian Pain, and Brealey/Myers/Allen, which method works best in order to define a good investments.
So what is the Net Present Value? The NPV is today's value of the difference between cash inflows and outflows projected at future dates. When a firm makes profit it can either reinvest the cash or return it to the investor. If cash is reinvested then it should offer a better rate of return as one that shareholders could have gained by investing in financial assets themselves. Two essential points are to be considered in a good method of investment appraisal. The first one is the fact cash is king (that is the fact, cash as soon as available can be invested in some way or another) and the second is the time value of money (Receipt of £100 today has more value than receipt of £100 in one year's time). This is due to the fact, first that, the money could have been invested immediately, where you would or could have made a capital gain and, second that, purchasing power is lost every year due to inflation.
The percentage rate by which the money is eroded over one year is called the discount rate. The amount by which the value of say £x is eroded over one year is calculated by dividing it by what is called the discount factor.
£x (1 + discount rate %)
Investment appraisal methods in which a technique of discounting the projected cash
So what is the Net Present Value? The NPV is today's value of the difference between cash inflows and outflows projected at future dates. When a firm makes profit it can either reinvest the cash or return it to the investor. If cash is reinvested then it should offer a better rate of return as one that shareholders could have gained by investing in financial assets themselves. Two essential points are to be considered in a good method of investment appraisal. The first one is the fact cash is king (that is the fact, cash as soon as available can be invested in some way or another) and the second is the time value of money (Receipt of £100 today has more value than receipt of £100 in one year's time). This is due to the fact, first that, the money could have been invested immediately, where you would or could have made a capital gain and, second that, purchasing power is lost every year due to inflation.
The percentage rate by which the money is eroded over one year is called the discount rate. The amount by which the value of say £x is eroded over one year is calculated by dividing it by what is called the discount factor.
£x (1 + discount rate %)
Investment appraisal methods in which a technique of discounting the projected cash
Bibliography: Business accounting and finance, Tony Davies, Brian Pain, ed 1999, McGraw Hill Corporate Finance, eighth edition, Brealey/Myers/Allen, Mc Graw Hill, 2006-03-05, pages 84-104 http://www.thelimesconsultancy.com/capital_investment_appraisal.htm#Investment%20appraisal%20–%20introduction