Introduction to Discounted Cash Flow – NPV
In this lecture we will be looking at how the Financial Manager should go about making capital investment decisions. For example, they may have to decide whether or not it is worthwhile investing $1,000,000 in a new factory. Alternatively they may have to make the choice between several available investments.
Discounted Cash Flow – Net Present Value
This approach looks at the expected cash flows from the investment in question. If over the life of the investment there is an expected cash surplus, then the project will be accepted, whereas if an expected cash deficit the project will be rejected.
To account for the fact that money will be tied up in the project over a period of years (and will therefore either result in interest being paid on money borrowed for the investment, or interest lost on the money invested), the cash flows are discounted at the cost of money (or cost of capital) to the company before calculating the net surplus or deficit and making the decision.