What is net present value?

Question

Quizplus · Accepted Answer

The Answer is The net present value (NPV)of an investment project is the difference between the project's present value (PV),the value of a portfolio of financial instruments that track the project's future cash flows,and the cost of implementing the project.Projects that create value are those,whose PVs exceed their costs,and thus represent situations where a future cash flow pattern can be produced more cheaply,internally,within the firm,than externally,by investing in financial assets.These are called positive NPV investments.Adopting a project at a cost less than the PV of its future cash flows,i.e positive NPV,means that financing the project by short-selling this tracking portfolio leaves surplus cash in the firm today.Since the future cash that needs to be paid out on the shorted tracking portfolio matches the cash flows coming in from the project,the firm that adopts the positive-NPV project creates wealth risklessly.In short,adopting a risk less project with a positive NPV and financing it in this manner is an arbitrage opportunity for the firm.The wealth-maximizing NPV criterion is that: (1)all projects with positive NPVs should be accepted (2)all projects with negative NPVs should be rejected.

What Is Net Present Value