StudyCorgi Business & Economics

The Net Present Value Concept

Introduction

The Net Present Value Rule (NPV) states that in the case of a positive NPV, an investment is to be accepted and in the case of a negative NPV, the investment should be rejected. The NPV Rule stipulates that by investing in the projects that have the NPV over zero, the company or the shareholder have a chance of gaining an increased profit (Investopedia, n.d., par. 1). Thus, NPV serves as calculation metric for the company’s management to decide whether it is worth investing in a particular project.

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Net Present Value of Zero

A Net Present Value of Zero means that investing in such a project will neither yield profits nor incur losses (Net Present Value Rule, n.d., par. 3). Thus, a company will not increase or decrease in value with such an investment. In such case, an investor pays the exact value of the asset in question. When faced with a decision whether to invest in an NPV-zero-value project, it is necessary to consider all aspects of the problem.

When a given acquisition or a project has a Net Present Value of zero, it means that there is neither a prospect of profit nor a risk of incurring additional expenses. Thus, other aspects of the investment must be analyzed. As the main concern for investments is adding value to the company, it is necessary to indicate other aspects of the particular project that could add value to the company. Therefore, the company management might base their decision on the consideration of the non-monetary factors (Net Present Value Rule, n.d., par. 6). These factors might include aspects that are beneficial for the company despite not gaining any profits, such as employee benefits, charitable purposes, and things that might benefit or improve the company management processes. It is necessary to consider the non-monetary aspects, as well as financial profit, as the former can often prove to be beneficial for the overall image and reputation of an enterprise and ensure consistent profits in the long-term sense.

Forecasting Error (Risk)

In finance and business management, “forecasting error” term is used to describe a planning technique that ensures an efficient analysis of the company’s viability and the market situation. This method plays a crucial role in the analysis of the capital expenditure projects, as it involves present and past data processing, as well as an analysis of the current market trends. By interpreting and correlating the obtained data with the current trends and emerging economic tendencies, it is possible to manage the aspect of uncertainty, thereby assessing the risks that may be involved (Forecasting 101: A guide to forecast error measurement statistics and how to use them, n.d., par. 1). Error management statistics are acquired due to the analysis method outlined above. Thus, forecasting error entails data processing and the correlation with the recent market trends. Such approach allows for predicting the risks involved and making strategically sound decisions.

Conclusion

The Net Present Value Rule helps the company management make a decision regarding investment issues. Whether to invest in a project or not is thereby based on whether the NPV of a potential acquisition is negative, positive, or neutral. When deciding whether to invest in a project with a zero NPZ, it is crucial to analyze the non-monetary values. Forecasting error method allows for estimating the risks involved and making a sound decision.

References

Forecasting 101: A guide to forecast error measurement statistics and how to use them. (n.d.). Web.

Investopedia. (n.d.). Net Present Value Rule. Web.

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Net Present Value Rule. (n.d.). Web.

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StudyCorgi. (2020, December 29). The Net Present Value Concept. Retrieved from https://studycorgi.com/the-net-present-value-concept/

Work Cited

"The Net Present Value Concept." StudyCorgi, 29 Dec. 2020, studycorgi.com/the-net-present-value-concept/.

1. StudyCorgi. "The Net Present Value Concept." December 29, 2020. https://studycorgi.com/the-net-present-value-concept/.


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StudyCorgi. "The Net Present Value Concept." December 29, 2020. https://studycorgi.com/the-net-present-value-concept/.

References

StudyCorgi. 2020. "The Net Present Value Concept." December 29, 2020. https://studycorgi.com/the-net-present-value-concept/.

References

StudyCorgi. (2020) 'The Net Present Value Concept'. 29 December.

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