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 …show more content…
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 of NPV The strengths of using NPV are that the equation has already figured in the costs of the project and therefore, the answer to the equation is stating how much can be expected to be earned from it. The main weakness is that NPV is often misunderstood by individuals in management who do not have a full understanding of its utility. NPV also does not take into consideration the debt repayments of a company that is must meet. Therefore, a company that was considering purchasing another company might be mislead as to the total debt of the other company if NPV were the valuation method used.
Adjusted Present …show more content…
Internal rate of return is a ratio that is calculated to determine the interest rate that would make the NPV of a business equal to zero (Cornett et al, 2015). In other words, it is the rate at which equity or financing should be acquired in order to meet the financial demands of the project or business. IRR is useful only if cash flows for the project or business are considered normal. The payback method is limited in that it only tells a decision-maker at what point the business generates cash inflows equal to the cash outflows required to operate it. This might also be thought of as the point at which the business ‘breaks even.’ Therefore, this method does not allow for the calculation of
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 …show more content…
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 of NPV The strengths of using NPV are that the equation has already figured in the costs of the project and therefore, the answer to the equation is stating how much can be expected to be earned from it. The main weakness is that NPV is often misunderstood by individuals in management who do not have a full understanding of its utility. NPV also does not take into consideration the debt repayments of a company that is must meet. Therefore, a company that was considering purchasing another company might be mislead as to the total debt of the other company if NPV were the valuation method used.
Adjusted Present …show more content…
Internal rate of return is a ratio that is calculated to determine the interest rate that would make the NPV of a business equal to zero (Cornett et al, 2015). In other words, it is the rate at which equity or financing should be acquired in order to meet the financial demands of the project or business. IRR is useful only if cash flows for the project or business are considered normal. The payback method is limited in that it only tells a decision-maker at what point the business generates cash inflows equal to the cash outflows required to operate it. This might also be thought of as the point at which the business ‘breaks even.’ Therefore, this method does not allow for the calculation of