11/1/2016

AdvantagesoftheNPVmethod

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NPViseasytouse,easilycomparable,andcustomizable.
LEARNINGOBJECTIVE [edit]
Describetheadvantagesofusingnetpresentvaluetoevaluatepotentialinvestments

KEYPOINTS [edit]
WhenNPVispositive,itaddsvaluetothefirm.Whenitisnegative,itsubtractsvalue.Aninvestorshould
neverundertakeanegativeNPVproject.
Aslongasalloptionsarediscountedtothesamepointintime,NPVallowsforeasycomparisonbetween
investmentoptions.TheinvestorshouldundertaketheinvestmentwiththehighestNPV,provideditis
possible.
AnadvantageofNPVisthatthediscountratecanbecustomizedtoreflectanumberoffactors,suchasrisk
inthemarket.

TERM [edit]

gain(orloss)
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AdvantagesoftheNPVmethod

Ifaninvestmentearnsmorevaluethanitcosts,thedifferenceisthegain.Ifitcostsmorethanitearns,the
differenceisaloss.

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FULLTEXT [edit]

CalculatingtheNPVisawayinvestorsdeterminehow
attractiveapotentialinvestmentis.Sinceitessentially
determinesthepresentvalueofthegainorlossofan
investment,itiseasytounderstandandisagreat
decisionmakingtool.
WhenNPVispositive,theinvestmentisworthwhile
Ontheotherhand,whenitisnegative,itshouldnotbe
undertakenandwhenitis0,thereisnodifferencein
thepresentvaluesofthecashoutflowsandinflows.In
theory,aninvestorshouldundertakepositiveNPV
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investments,andneverundertakenegativeNPV
investments.Thus,NPVmakesthedecisionmaking
processrelativelystraightforward.

NPVDecisionTable
NPVsimplyandclearlyshowswhetheraprojectaddsvaluetothefirmornot.It'seasyofuseindecision
makingisoneofitsadvantages.

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AnotheradvantageoftheNPVmethodisthatitallowsforeasycomparisonsofpotentialinvestments.Aslongas
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theNPVofalloptionsaretakenatthesamepointintime,theinvestorcancomparethemagnitudeofeach
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option.WhenpresentedwiththeNPVsofmultipleoptions,theinvestorwillsimplychoosetheoptionwiththe

highestNPVbecauseitwillprovidethemostadditionalvalueforthefirm.However,ifnoneoftheoptionshasa
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11/1/2016

AdvantagesoftheNPVmethod

positiveNPV,theinvestorwillnotchooseanyofthemnoneoftheinvestmentswilladdvaluetothefirm,sothe
firmisbetteroffnotinvesting.
Furthermore,NPViscustomizablesothatitaccuratelyreflectsthefinancialconcernsanddemandsofthefirm.
Forexample,thediscountratecanbeadjustedtoreflectthingssuchasrisk,opportunitycost,andchangingyield
curvepremiumsonlongtermdebt.
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Referencedin1quizquestion

WhichofthefollowingisanadvantageofusingtheNPVmethodtoevaluate
differentprojects?

KEYTERMREFERENCE

Opportunitycost

Appearsintheserelatedconcepts:DefiningthePaybackMethod,The

ImportanceofMotivation,andDefiningComparativeAdvantage

cashoutflow

Appearsintheserelatedconcepts:ReportingFinancingActivities,DefiningNPV,

andSelectedFinancialRatiosandAnalyses

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debt

Appearsintheserelatedconcepts:DebtUtilizationRatios,DeficitSpending,thePublic
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Debt,andPolicyMaking,andCollectionfromDelinquentPayables

discount

Appearsintheserelatedconcepts:TheDiscountRate,ParValueatMaturity,and
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PresentValue,MultipleFlows

discountrate

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Appearsintheserelatedconcepts:DiscountedCashFlowApproach,The

DiscountRate,andTheFederalReserveandtheFinancialCrisisof2008
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11/1/2016

AdvantagesoftheNPVmethod

forwards

Appearsintheserelatedconcepts:SecondaryMarketOrganizations,TypesofMarket

Organizations,andReportingofFinancialStatementAnalysis

investment

Appearsintheserelatedconcepts:FunctionsofCorporateFinance,TheRoleofthe

FinancialSystem,andGDPEquationinDepth(C+I+G+X)

investor

Appearsintheserelatedconcepts:AdvantagesofPrivateFinancing,Agency,and

FinancialInstruments

presentvalue

Appearsintheserelatedconcepts:CapitalLeasesvs.OperatingLeases,

CalculatingValuesforDifferentDurationsofCompoundingPeriods,andPresentValueandtheTimeValueof
Money

risk

Appearsintheserelatedconcepts:TheExportImportBankoftheUnitedStates,Approaches

toAssessingRisk,andRisksInvolvedinCapitalBudgeting

yield

Appearsintheserelatedconcepts:BondsPayableandInterestExpense,StockWarrants,

andCalculatingtheYieldofanAnnuity

yieldcurve

Appearsintheserelatedconcepts:TheYieldCurve,DefaultRiskandBondPrice,

andChapterQuestions

SOURCES

Boundlessvetsandcurateshighquality,openlylicensedcontentfromaroundtheInternet.This
particularresourceusedthefollowingsources:
"Boundless."
http://www.boundless.com/
BoundlessLearningCCBYSA3.0.
"Netpresentvalue."
http://en.wikipedia.org/wiki/Net_present_value
WikipediaCCBYSA3.0.
"Boundless."
http://www.boundless.com//finance/definition/gainorloss
BoundlessLearningCCBYSA3.0.
"NPVandtheTimeValueofMoney."

WelcometoBoundless!Seehowwecanhelp.

http://su3finance.wikispaces.com/Chapter+4++NPV+and+the+Time+Value+of+Money
su3financeWikispaceCCBYSA3.0.
"PrinciplesofFinance/Section1/Chapter2/TimeValueofMoney/PVandNPV."

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http://en.wikibooks.org/wiki/Principles_of_Finance/Section_1/Chapter_2/Time_Value_of_Money/PV_and_NPV%23What_NPV_Me
WikibooksCCBYSA3.0.

CITETHISSOURCE

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Source:Boundless.AdvantagesoftheNPVmethod.BoundlessFinance.Boundless,20Sep.2016.Retrieved01Nov.
2016fromhttps://www.boundless.com/finance/textbooks/boundlessfinancetextbook/capitalbudgeting11/netpresent
value94/advantagesofthenpvmethod4103863/

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