Principles of Managerial Finance, 15th Edition

10.3 Net Present Value (NPV)

1. LG3

The method used by most large companies to evaluate investment projects is called net present value (NPV). The intuition behind the NPV method is simple. When firms make investments, they are spending money that they obtained, in one form or another, from investors. Investors expect a return on the money that they give to firms, so a firm should undertake an investment only if the present value of the cash flow that the investment generates is greater than the cost of making the investment in the first place. Because the NPV method takes into account the time value of investors’ money, it is more likely to identify value-increasing investments than is the payback rule. The NPV method discounts the investment’s ...