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Net Present Value

Forums › FIA Forums › MA2 Managing Costs and Finance Forums › Net Present Value

  • This topic has 1 reply, 2 voices, and was last updated 1 year ago by Ken Garrett.
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  • March 16, 2021 at 12:25 pm #614516
    maximus07
    • Topics: 374
    • Replies: 379
    • ☆☆☆☆

    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.

    March 16, 2021 at 5:51 pm #614551
    Ken Garrett
    Keymaster
    • Topics: 10
    • Replies: 9977
    • ☆☆☆☆☆

    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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