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424 Corporate Finance BRILLIANT’S
3. NPV is always based on the objective of 3. Bg nÕ{V H$m CÔoí` A§eYm[a`m| H$s doëW _¡[ŠO_mBO
maximising the shareholder's wealth. This H$aZm hmoVm h¡Ÿ& Bg H$maU Bg nÕ{V H$m _hËd g~go
is the greatest virtue of the method. A{YH$ h¡Ÿ&
Limitations H${_`m±
1. In practice, it is quite difficult to obtain the 1. dmñVd _| A{ZpíMVVm Ed§ {S>ñH$mCÝQ> aoQ> Ho$ H$maU
estimates of cash flows due to uncertainty H¡$e âcmoO H$m AZw_mZ bJmZm H${R>Z hmoVm h¡ &
and discount rate.
2. When alternative projects with unequal 2. O~ AbJ-AbJ OrdZ H$mb dmbo àmoOoŠQ²>g H$m
lives are evaluated, then caution must be _yë`m§H$Z {H$`m OmVm h¡ V~ Bg nÕ{V H$m Cn`moJ
taken. gmdYmZrnyd©H$ H$aZm hmoVm h¡Ÿ&
Evaluation of the NPV Method NPV _oWS> H$m _yë`m§H$Z
The NPV method can be used to select one `h _oWS> Xmo `m Xmo go A{YH$ å`yMwAbr EŠgŠby{gd
project between mutually exclusive projects. àmoOoŠQ²>g _| go {H$gr EH$ H$m M`Z H$aZo _| Cn`moJr h¡Ÿ& {Og
One with the higher NPV should be selected.
NPV is the true measure of an investment's àmoOoŠQ> H$m NPV A{YH$ hmoVm h¡ Cgo àmW{_H$Vm Xr OmVr h¡Ÿ&
profitability. NPP NPV BÝdoñQ>_|Q> H$s àm°{\$Q>o{~{bQ>r H$m dmñV{dH$ _mn hmoVm h¡Ÿ&
It should be clear that the acceptance rule `h ñnï> h¡ {H$ `{X NPV nm°{O{Q>d h¡ (NPV > 0)
using the NPV method is to accept the
Vmo àmoOoŠQ> ñdrH$m`© hmoJm Am¡a `{X {ZJo{Q>d h¡ (NPV < 0)
investment project if its net present value is Vmo Cgo {ZañV H$a {X`m OmEJmŸ& `{X nm°{O{Q>d ZoQ> àoOoÝQ>
positive (NPV > 0) and to reject it if the net
present value is negative (NPV < 0). The market d¡ë`y dmco àmoOoŠQ²>g H$mo ñdrH$ma {H$`m OmE Vmo \$_© Ho$
value of the firm's share would increase if eo`a H$s _mH}$Q> d¡ë`y ~‹T> OmVr h¡Ÿ& Eogm Bg{bE hmoJm {H$
projects with positive net present value are nm°{O{Q>d> ZoQ> àoOoÝQ> d¡ë`y Ho$db V^r hmoJm O~ n«moOoŠQ
accepted. This will be so because the positive H¡${nQ>b H$s Anm°À`y©{ZQ>r H$m°ñQ> H$s VwbZm _| A{YH$ H¡$e
net present value will result only if the project
would generate cash inflows at a rate higher BZâbmo CËnÝZ H$aoJmŸ& `{X NPV= 0 h¡ Vmo àmoOoŠQ> H$mo
than the opportunity cost of capital. A project ñdrH$ma {H$`m Om gH$Vm h¡Ÿ& NPV eyÝ` hmoZm `h Xem©Vm
may be accepted if NPV= 0. A zero NPV implies h¡ {H$ àmoOoŠQ>, H¡${nQ>c H$s Anm°À`©w[ZQ>r H$m°ñQ> Ho$ ~am~a
that project generates cash flows at a rate just aoQ> na H¡$e âcmo CËnÞ H$aVm h¡Ÿ& AV: NPV H$s ñdrH¥${V
equal to the opportunity cost of capital. Thus
the NPV acceptance rules are: Ho$ {ZåZ{c{IV {Z`_ h¢:
Accept NPV > 0
Reject NPV < 0
May or may not accept NPV = 0
The NPV method can be used to select NPV nÕ{V H$m Cn`moJ nañna {^Þ àmoOoŠQ> Ho$ ~rM
between mutually exclusive projects; the one MwZmd _| {H$`m Om gH$Vm h¡Ÿ& {OgH$m NPVA{YH$ hmo CgH$m
with the higher NPV should be selected. Using M`Z H$aZm Mm{hEŸ& NPV nÕ{V H$m Cn`moJ H$aVo hþE, ZoQ>
the NPV method, projects would be ranked in àoOoÝQ> d¡ë`y Ho$ AmYma na àmoOoŠQ> H$mo a¢H$ Xr OmEJr AWm©V²
order of net present values that is, first rank will
be given to the project with highest positive net g~go A{YH$ nm°{O{Q>d ZoQ> àoOoÝQ> d¡ë`y dmco àmoOoŠQ> H$mo
present value and so on. àW_ a¢H$ Xr OmEJr Am¡a Bgr àH$ma AÝ` H$mo ^r Xr OmEJrŸ&
