Page 110 - DBP5043

PROJECT VALUATION TECHNIQUES

NET PRESENT VALUE (NPV):

Is a valuation technique that takes into account the present value of money.
In general, the present value of RM1 at the present time would not be the
same value for the past 10 years. NPV for a project is equal to the present
value of annual cash flow after tax minus the initial investment (Io)

The present value of annual cash flow after tax is dependent on the cost
of capital or required rate of return by a company.

NPV = Present value of annual cash flow after tax - the initial investment
(Io)
The selection criteria for a project:
A project will:
Received: NPV> 0 (positive) – ACCEPT Project – the higher the better
Less: NPV <0 (the negative) - REJECT Project

Net Present Value Advantages

It uses cash flows and therefore is able to reflect the true timing of the
flows involved.

It uses the time value of money concept to compare the benefits and costs
of a project. Earlier returns are always preferred than later returns.

It allows the company to know the exact impact of the project on the firm’s
value. A positive NPV project will increase the value of the firms by the
same amount. This is consistent with the goal of firm maximize
shareholder’s wealth.

Net Present Value Weaknesses:

In order to calculate NPV, we need to make long term forecast of future
cash flows.

We also need to determine the discount rate to be used and hence it is
time consuming

** based on Example 1, calculate the NPV If the rate of return required
is 13%