NET PRESENT VALUE

Fundamentals of Finance Corporate, Chapter 11 The Basics of Capital Budgeting, Net Present Value, NPV

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NET PRESENT VALUE by Mind Map: NET PRESENT VALUE

1. Definition

1.1. present value of the project's FCF discounted at the cost of capital

1.2. how much a project contributes to shareholders’ wealth

1.2.1. larger NPV, more value adds and higher stock price

2. Formula

2.1. Calculation

2.2. Explanation

2.2.1. Positive NPV = the project should be approved

2.2.2. Zero NPV = the project may or may not be passed

2.2.3. Negative NPV = the project is rejected

3. Pros & Cons

3.1. Advantages

3.1.1. Time Value of Money

3.1.2. Decision-making

3.2. Drawbacks

3.2.1. Hidden Cost

3.2.2. Hard to Determine the Required Rate of Return

3.2.3. Cannot compare projects with different life spans

4. NPV Decision Rules

4.1. Independent: accepted if NPV >0

4.2. Mutually Exclusive: accepted if NPV is the highest positive one; meanwhile, reject all if there is no positive NPV project.

5. EXAMPLES

5.1. Based on independent projects, choose both Project S & L

5.2. Based on mutually exclusive projects, choose Project L