The Book Finance : Applications And Theory Essay

847 Words Nov 16th, 2016 4 Pages
Valuation Methods In the book Finance: Applications and Theory (2015), Cornett, Adair and Nofsinger state that net present value (NPV) is the purest form of capital budgeting, because it measures the amount of wealth increase we expect from a project. This is really one of the only questions a manager or decision-maker is concerned with when considering approving a project. How much money will it make for the company?
Net Present Value Net present value is calculated by subtracting the present value of all expected expenditures for the project up front and adding the present value of all expected or projected revenue. If the total sum is positive, then the project should theoretically be approved on the basis that inflows of cash will be greater than outflows of cash. The actual equation is shown below:

NPV = [CF0 / (1+i)0] + [CF1 / (1+i)1] + …+ [CFN / (1+i)N]

where
CF = cash outflows at the beginning of the project
N = the given number of the cash flow and i = the rate at which the cash outflows will accumulate interest or the discount rate

In terms of a project valuation tool, NPV is a very straightforward approach and offers sound logic to determine the profitability of a proposed project. But what about valuing an entire business the same way? NPV can be used to determine if a company is a worthwhile investment for potential buyers or investors. In a business acquisition scenario, NPV is called discounted cash flow model (Gallo, 2014).
Strengths and Weaknesses…

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