Net Present Value: Safe Investment Yields
Net present value (NPV) of an annuity is basically the difference between the amount of money inflow and outflow out of an annuity presently. NPV is actually a mathematical term. It is used in budgeting to calculate the profit and loss of an investment or a project with time. It considers the present inflow of cash but is also sensitive to the future inflows of cash that an investment yields. NPV compares the value of a particular amount of money presently with its value in future. While doing this, it considers rate of returns and inflation rates too. If the value comes out to be positive, the project is carried over. If not, the project is rejected because in future the money flowing in under this project will also be lower than the current.
Consider the following as an example. Suppose a businessman is willing to buy a store for his retailing business. In order to calculate the profits gained by the store in future, he will first generate a picture of future cash flows generated by the store. Then he will put this as some lump sum amount. If the present owner of this store is willing to sell it at a price lesser than this lump sum amount, the businessman will definitely go for it. This is because the NPV shows a positive picture otherwise there is no point in buying it. In order to understand what net present value is, it is most important to understand what the time value principle states. Lets check out some frequently asked questions relating to this topic. 1.What does TVM state? Time value of money principle states that it is better to have money now rather than later, if all parameters are equally placed. The principle is based on future value and present value of an investment or project. If you know what you can invest and till what period under a certain amount of time, the future value of an annuity can be calculated by calculating each value of the cash flowing in as per the given rate of interest. The present value of an annuity is calculated as per the present coupon payments that you will receive in the future. 2. In the context of TVM, explain what discount entails. Discount is a process of finding the NPV. In a single cash flow, it is divided by one plus the rate of interest for each and every period of time that will pass. 3. Summarize what NPV is all about. Net present value is a standard method for evaluating the financial status of long term projects. It is used for actually budgeting the capital through out the economics widely. It thus evaluates the excess or scarcity of cash flows, in terms of its present value of the money, once finances are met. It also marks investments this way as profitable if calculated NPV turns out to be positive. It marks stating non-Profitable investment if NPV is negative. It is important that big companies should take care of the NPV factor in order to maximize the profits in terms of greater opportunity cost. With this information on NPV, you can plan and evaluate your investment options for the future. |
