Homework Answers
Answer
- Steps in the Net Present Value method of Capital
Budgeting:
>Step #1: Determine the amount of capital investment required or projected.
>Step #2: Determine various annual cash inflows and outflows during the lifetime of that project or investment.
>Step #3: Determine a discount interest rate like 10%, 12% etc for discounting the future inflows/outflows to present values.
>Step #4: Once the discount rate is
determined, calculate the present value factor for each year:
Like for Year 1, if 10% rate is determined, PV factor would be:
1/(1.10)1, for Year 2, it will be
1/(1.10)2.
>Step #5: Multiply all annual future Cash inflows and outflows with respective ‘present value factor’ for that year determined in Step #4.
>Step #6: Total the Present values of all the future Cash inflows and outflows calculated in Step #5.
>Step #7: Calculate the Net Present
Value as
Net present value = Present values of all future cash inflow and
outflows ‘minus’ Cost of initial invested in Step #1.
>Step #8: Decision making
Step.
--If NPV in Step #7 is positive, The investment can be
accepted.
--If NPV in Step #7 is negative, the investment project should be
rejected.
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