Net present value is the most used technique of capital investment appraisal. In simple terms, net present value is the value of net cash flows arising from the project after discounting it with discounting factor, also known as the cost of capital.
Decision Criteria: A project should be accepted if the net present value of the project is positive or more than zero. If NPV is 0 or negative it should be rejected.
A five-step approach can be utilized to compute the NPV:
- Determine the cost of the project
- Estimate the project’s future cash flows over its forecasted life
- Determine the riskiness of the project and estimate the appropriate cost of capital
- Compute the project’s NPV
- Make a decision