Page 265 - BA2 Integrated Workbook STUDENT 2018

Long-term decision making

Net present value (NPV)

4.1 NPV technique

Typically an investment opportunity will involve a significant capital outlay initially with
cash benefits being received in the future for several years. To calculate the NPV:

 convert all future cash inflows into present value terms

 deduct the initial investment.

The NPV represents the surplus funds (after funding the investment) earned on the
project. This tells us the impact the project has on shareholder wealth.

Decision criteria

 Any project with a positive NPV is viable. It will increase shareholder
wealth.

 Faced with mutually-exclusive projects, choose the project with the
highest NPV.

Illustrations and further practice

Go over illustration 4

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