Concept of Net Present Value - Essay Example

The concept of net present value is an analytic tool that can help both corporations and novice investors. From an investor standpoint, the use of net present value is very useful because net present value takes into consideration the time value of money. Due to inflation money depreciates over time. A person who has $100 saved up in a cookie jar and leaves it there for five years will lose money because those $100 will not have the same purchasing power five years into the future. Using the net present value table can help a person determine how much interest is required to ensure that the individual does not lose purchasing power over time.

The net present value is also used in the corporate world as a capital budgeting technique referred to as NPV which is useful because it helps corporations determine which project to choose from when there are various alternatives. The net present value technique uses discounted yearly cash flows from projects to evaluate whether a project should be accepted or rejected (Besley, Brigham, 2000). The NPV method can be used to evaluate one project or various projects. When evaluating a single project the manager should accept the project if its net present value is above cero. Projects with negative net present value should be rejected. In the case when a manager has to choose among various projects the project with the highest net present value should be chosen over the others. The use of NPV for project selection ensures that companies achieve profitability from a project. Read More