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Strategic financial management - Essay Example

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Net Present Value gives more explicit concerns to the time value of money and it is as well considered more crucial in investment appraisal than the traditional methods of payback and accounting rate of return. Net Present Value is calculated by subtracting the initial…
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Strategic financial management
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Strategic financial management

Download file to see previous pages... ater than zero and thus positive and reject a project with a net present value that is less than zero, that is, negative net present value projects should be rejected. (Ross et al., 2002). The latter case is in a situation where only one project is being evaluated. In the event were the company is evaluating a number of projects, for which only one will be selected, the decision criteria is to first of all discard all projects with negative net present values and then select the project with the highest net present value among the positive NPV projects. (Ross et al., 2002; Myers and Brealey, 2002).
It measures the change in the net worth of the firm due to the project (Cheng et al., 1994). NPV can also be derived from “discounting the expected future payoff by the rate of returns offered by comparable investment alternatives” (Richard and Bill, 2003). The vital stage of calculating NPV is to estimate the opportunity cost of capital (discounted rate) properly in order to discount future cash flow that forecasted of investment project (Brealey, Myers and Marcus, 2007). Under this method, every project with a positive NPV can be accepted to invest (Frank, 1999). NPV is a superior method of investment appraisal in theory, and recent study approved that it the most preferred tool in practices in management perspectives (Patricia and Glenn’s, 2002). This could because of its major advantages in consideration of time value of cash flows. However, Michael (2004) indicated a weakness in application of NPV, managers face more difficult practical issues—such as the estimation and timing of cash flows. This adjustment could impact on likelihood of project acceptance. Additionally, NPV may fail as the method primary assumes there is no restriction on the amount of company’s investment, yet in practice there is a certain constraint on company’s investment budget, which depends on its size (Frank, 1999).
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