9.3 Net Present Value

The capital budgeting decision model that uses all the discounted cash flows of a project is net present value (NPV), one of the single most important models in finance. The NPV of an investment is the present value of all benefits (cash inflows) minus the present value of all costs (cash outflows) of the project.

The NPV model states all cash flow in present value or current dollars, and we “net” the inflow against the outflow to see if the net amount is positive or negative. If the net amount is positive (benefits exceed costs), the project or choice is a “go.” If the net amount is negative (costs exceed benefits), the project is a “no-go.” If we are comparing two projects, we select the one with the highest positive NPV. ...

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