According to Attrill and Mclaney, 2009, there are four (4) approaches to capital budgeting. The net present value (NPV) is one of such and is a summation of all discounted cash flows(Present Value) associated with whichever project(s) are undergoing appraisal.
Every appraisal method have decision rules, examples include the Payback Period(PBP) which stipulates the approval of projects that pays back the initial investments within a specific period. For this method (Net Present Value) to be most effective, from the pool of prospective projects under review, only projects that produce a positive net present value should be undertaken, and projects that produce negative figures should be ignored and in instances where mutually exclusive projects are involved, management should thus undertake the project that generated the highest positive net present value.
There are however two types of projects that can be undertaken, these are independent projects that are not affected by the cash flows of other projects, and on the other hand is the mutually exclusive projects that means that there are two ways at accomplishing same results.
Investment involves making an outlay of something of economic value, usually cash, at one point in time, which is expected to yield economic benefits to the investor at some other point in time. (Atrill and Mclaney, 2009).
The Business plan on Project planning and evaluation
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Among all the methods of appraisals and despite the fact that this method is however more difficult than the other methods to calculate, the Net Present Value represents the most logical approach, business owners and investors can utilize when making an investment decision / during capital budgeting.
When compared to other methods of project appraisal, it particularly stands out.The essential feature of investment decisions is time, (Atrill andMclaney, 2009) and this method particularly recognizes the importance and calculates the time value of money, furthermore, this method measures in absolute terms, the increase in the wealth of shareholders through the acceptance of the project(s), it is also additive, in other words decisions can be reached on a number of projects, simply through the addition of their different respective Net Present Values (NPV’s).
Unlike the Payback period method, it measures projects by the utilization of all cash flows of the project.
For example, a real estate company, PropertyMart, Nigeria wishing to acquire an already existing apartment, would in utilizing the NPV analyze the future cash flow to be generated from the said apartment, after this analysis is done, the firm then puts into consideration, its cost of capital and initial investment. calculating the NPV would involve the summation of the cash flows starting from year 0, which is an outflow so it’ll produce a negative figure to the projected future cash flows which would be positive values.
If the product of this NPV is positive, then the investment would be worthwhile, and if there are options A to D of prospective investments, PropertyMart would invest in the property that generates the highest NPV upon calculation.
REFERENCE Atrill, P & McLaney, E (2009) Management Accounting for Decision Makers, 6th ed. Harlow, England: Pearson Education Ltd.
The Term Paper on The internal rate of return (IRR) and the net present value (NPV)
... evaluating investment proposals. But just like the NPV it satisfies the criteria required for the correct evaluation o0f capital projects by using cash flows as ... can be confusing but if you use the NPV method to analyse the same project, you get one single answer. The IRR ... A and Shawn. Forbes, 1993, 揇ecision making and Display Methods. The case of prescription and practice in capital budgeting, the ...
