Capital Budgeting: The Net Present Value

The net present value of budgeting used the concept of the time value of the money and evaluates the project for the investment on the bases of cash flows, total project costs and service value of the project. The net present value method of budgeting establishes a relationship between the amount of cash flows and the timings associated with this flow. In order to calculate net present value you need to know the cash outflows and cash inflows associated to that project. A simple formula can be used to have an idea of net present value as under:-

NPV= Present Value of Benefits – Present Value of Money

In consideration there are three values of the Net Present Value and these indicate different illustrations as described as under:-

NPV Positive shows that Benefits are greater than the cost of the project

NPV Zero shows that Benefits are equal to the total cost of the project

NBV Negative shows that Benefits are less than the cost applied to the project

In simplified explanation the positive value of NPV shows that the benefits of the projects are greater than the actual cost spent on the project and the project can recover asset costs, cost of financing and will also earn a profit for the company as well. The Zero value of NPV indicates that project won’t earn any profit for the company however the company will achieve breakeven with this project. The negative value of NPV indicates that there are no benefits associated with the project and it won’t be able to recover its cost as well.

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