Investing Feeds

Net Present Value (NPV) Part Two

Before the worked examples, it is important that you read the first part of NPV, as the underlying concepts, and their limitations, are very important. To utilize NPV as a tool for ranking Investments it is important to arrive at a rate at which to discount the estimated future cash flows. In terms of Share purchases, future cash flows are either dividends paid, or increase in share value. The following is a highly simplified example, and care should be taken when arriving at estimates of growth and dividend payments, as well as the rate at which those estimates are discounted.

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If you invest in a firm, you want to hope they utilize NPV as a tool for vetting potential projects, as this method is the only mathematically correct measure of the Economic Value Added (EVA) to a company (which should then equate to Market Value Added (MVA), or an increase in share price.) NPV is a method of discounting future revenue to arrive at a dollar figure which is the present value of that revenue today (or as Economists say, at time period 1.) [Read more]