The money you have today

is always an asset and it worth’s more than what it will be in the future, the reason

being the future is unpredictable to us (Gallo, 2014).

Maybe there is inflation or a sudden economic down turn. Secondly, the cash or

an asset you are holding today can be invested and you can earn more. So, to

estimate the financial worth of what you are holding today and what it will be

in the future, NPV is used (Gallo, 2014).

According to Hillier,

Ross, Westerfield, Jaffe & Jordan (2010) net present value is the method

that is most frequently used in business today that has been used by investors

to make investment decisions. Many decision-makers have termed it as most

correct and accurate than payback and discounted payback period. Net present

value is the technique used to assess physical asset investment projects which

take into account the projects which could be lucrative for the businesses. The

technique is especially used for the projects that are large in value, quantity

and money. As far as the discounted cash flow approach is concerned, it is an

element of net present value. The only difference between net present value and

discounted cash flow model is that, the net present value deducts the initial

investment after getting the present value of cash flows. (Hillier, Ross, Westerfield, Jaffe, & Jordan, 2010).

Net present value is also

useful from an investor point of view and can help a lot while deciding on whether

to invest in a company or not (Linn, 2018).

According to him, when an investor is planning for investing in a company, they

always try to invest in such a stock which will give them the highest return

and there is no shortcut to that. Net present value can be used to evaluate

whether it will be a good investment or not. For example, a stock worth $1000

today and inflation is 2 % per year, meaning after one year you can only buy

stuff valuing $980. Expected profit is 3%, so the net present value today is

$1030 divided by one plus inflation rate, you will get $1009.8 that means a

positive net present value. If you get a positive or zero net present value,

that means you are good to go and can invest but when it comes to investing in

stocks, you need to go a bit further. The next step is to look for shares

available in that particular company and then you divide the net present value

with available shares to get net present value per share. Consider a company

with the net present value of $20,000 has 2,000 shares. That means you have a

net present value of $10 per share. The next step is to look for the market

price of that particular share, if that is $4, you can invest but if it’s $14,

the share is already overpriced. On the other hand, this method also has some

limitations i.e. you always don’t know the growing percentage of the company

and deciding on discount factor is critical because if a company decides to

invest in a new project or introducing a new product line and all these

investment decisions has risk aspect also (Linn, 2018).

In today’s competitive

world, the key to success is always growing. From a company’s point of view, it

also includes investment in different projects, and to decide whether to invest

or not a large number of companies use net present value approach (Hillier, Ross, Westerfield, Jaffe, & Jordan,

2010).

Net present value employs discounted cash flow technique in the analysis which

makes the net present value method most widely used as it takes into account

both risk and cash flows. The method assesses estimated cash flows that would

be extracted from the project by discounting them to the current time period

making use of time span of the project and firm’s weighted average cost of capital.

The result is evaluated on the basis of being positive or negative. In case of

the positive figure, the project would be financially feasible and company

should carry on with the project and if the result is negative, the project

should be out rightly rejected without weighing any other factor (Hillier, Ross, Westerfield, Jaffe, & Jordan,

2010).

(Cheng, Kite, & Radtke, 1994) narrated that before

applying the net present value method it’s important to figure out whether the

project is mutually exclusive or independent project. Independent projects are

those not having any link with the cash flow of other projects. However,

mutually exclusive projects are entirely different. The mutually exclusive

projects mean that there are two ways of accomplishing the same result but only

one could be opted as choosing one would make it impossible to choose the

other. When investor evaluates two different projects based on the NPV

criterion, it’s crucial to find out the type of project in order to make accept

or reject decision. In case of independent projects, the project with any value

greater than zero should be chosen. While in case of a mutually exclusive

project, if NPV of one project is greater than NPV of the other project, the

project with the highest NPV should be accepted. If both projects are yielding

negative NPV, both projects should be rejected (Cheng, Kite, & Radtke, 1994).

In simple words, Net

present value technique calculates the present value of the cash flows on the

basis of the opportunity cost of the capital and calculates the figure which

will be added to the wealth of the shareholders if the project is accepted (Cheng, Kite, & Radtke, 1994).