NPV and IRR are two of the key methods of conducting an investment appraisal. Whilst both methods offer a comprehensive investment appraisal, they can also be tricky to calculate and hard to explain to the uninitiated.
What Does NPV Indicate?
NVP or net present value, essentially gives the analyst a financial value or worth of a project based upon the use of a discounted cash flow. The cash flow is discounted so as to represent the time value of money, analysts often use a company’s WACC as the appropriate discount rate. The rate is then often amended to reflect the relative risk of a project, higher risk projects being subjected to a higher discount rate.
Once a discounted cash flow has been constructed, the initial investment is then subtracted from the sum of the cash flows, where the figure is positive this indicates that the project adds value and should be accepted. Where the figure is negative, this indicates that the project subtracts value and should be rejected.
