According to Fernando(2023), the computational steps of a Net Present Value (NPV) calculation involve the following: 1. Defining NPV: NPV is the sum of the present values of cash inflows and outflows. 2. Discounting Cash Flows: Because of the time value of money, cash inflows and outflows can only be compared at the same point in time. NPV discounts each inflow and outflow to the present, using a discount rate, to make them comparable. 3. Calculation: The NPV is calculated by summing the present values of each individual cash flow using the formula: NPV = PVInflows - PVOutflows Where PVInflows are the present values of cash inflows, and PVOutflows are the present values of cash outflows. Cash inflows are typically positive, while cash outflows are negative. 4. Interpreting NPV: - A positive NPV means the investment is worthwhile, as the value of the inflows exceeds the outflows. - NPV equal to 0 means the inflows equal the outflows, indicating no gain or loss. - A negative NPV means the investment is not good, as the outflows exceed the inflows. 5. Decision Making: Management uses the NPV to make decisions about projects. In theory, they should invest in projects with a positive NPV, as these projects add value to the firm. However, in practice, the decision also depends on other factors, and the accuracy of the inputs (discount rate, cash flow estimates) can impact the decision-making process. 6. Advantages of NPV: NPV is easy to use, allows for easy comparison of investment options, and can be customized by adjusting the discount rate to reflect various factors like risk. 7. Disadvantages of NPV: NPV relies on estimates and may not fully account for opportunity costs. It also does not provide a complete picture of an
investment's gain or loss. 8. NPV Profiles: NPV profiles graph the relationship between NPV and discount rates, showing how changes in the discount rate affect NPV. The discount rate at which NPV equals 0 is called the Internal Rate of Return (IRR). Reference: Fernando, J. (2023, May 24). Net Present Value (NPV): What It Means and Steps to Calculate It. Retrieved from https://www.investopedia.com/terms/n/npv.asp
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