Running a business organization comes with numerous responsibilities in order to ensure smooth operation. There are a number of business related terms that tend to play a crucial role in determining the success of any business. One such term that you need to evaluate is Net Present Value or NPV related to your business entity. To put into simple words, NPV can be ascertained by all the present values of cash flows involved, be it inflow or outflow.
Furthermore, it can be narrowed down to the actual difference between revenues generated and costs incurred. Its objective is to contribute towards the wealth maximization for the stakeholders and owners. This article aims at portraying how NPV calculation is essential for any business organization.
Helps in ascertaining the figurative viability of a project
NPV being just another technique of capital budget building, gives you a figurative result. It provides you with an actual figure (in monetary terms) by discounting the present value of all future cash flow at the marginal cost of capital.
You can go with the project which reflects a positive NPV, as it is expected to bring in some profits. While on the other hand, a negative NPV indicates loss and such project should not be pursued by you. This way you can readily figure out whether any venture is going to be profitable for your company or not.
You can either do the calculations traditionally by using a pen and paper, or you can make use of an NPV calculator to carry out the process. It is an effective tool for calculating the net present value of your investment options so as to assist you in choosing the right and profitable one.
Estimating the effectiveness of capital investment
Net present value helps you in evaluating whether the investment is worth the money. Capital expenditures involve a considerable sum with underlying benefits for upcoming years. So, it would be wise to consider calculating the NPV of the investments you are looking forward to investing in. The primary function of this method is to analyze and compare the various options to find the most viable one. You can compare the present value of all effective future cash flows of the projects.
Takes time value of money in consideration
Unlike other methods of capital budgeting, NPV takes into account the time value of money. It helps you in estimating the value of a project by converting all future cash flows to today’s equilibrium. According to time value of money theory, assets in future might have lesser value than today. You can never know the earning prospects of today’s money. You can also get an idea about the opportunity cost involved in making the decision. As you leave a project alternative while choosing others, you’d be able to jot down the pros and cons of making a choice.
Therefore, it becomes evident that the net present value turns out to be a vital factor that any business company has to deal with from time to time.