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What is meant by these two different lines:
Line 1
“The discount rate is the rate of return that will be sufficient to cover the cost of the organisation’s capital.”Line 2
“In theory, the value of the organisation should increase by the amount of the NPV if the investment goes ahead.”Please explain.
An organisation’s cost of capital (CC) is a measure of the of interest and dividends the organisation has to pay investors. It’s like an interest rate. If that rate is 10% then any money raised by the company and invested has to earn at least 10% if the company is going to be able to adequately reward investors. The IRR is then 10%, a breakeven rate comparing earnings and payments to investors.
NPV is the present value of inflows less outflows discounted to the present. An NPV of, say, $10,000, is exactly equivalent to being given $10,000 now. A project yielding an NPV of $10,000 effectively makes the company $10,000 richer so its value should rise by that amount too.
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