Watch
Watching this resources will notify you when proposed changes or new versions are created so you can keep track of improvements that have been made.
Favorite
Favoriting this resource allows you to save it in the “My Resources” tab of your account. There, you can easily access this resource later when you’re ready to customize it or assign it to your students.
Advantages of the NPV method
NPV is easy to use, easily comparable, and customizable.
Learning Objective

Describe the advantages of using net present value to evaluate potential investments
Key Points
 When NPV is positive, it adds value to the firm. When it is negative, it subtracts value. An investor should never undertake a negative NPV project.
 As long as all options are discounted to the same point in time, NPV allows for easy comparison between investment options. The investor should undertake the investment with the highest NPV, provided it is possible.
 An advantage of NPV is that the discount rate can be customized to reflect a number of factors, such as risk in the market.
Term

gain (or loss)
If an investment earns more value than it costs, the difference is the gain. If it costs more than it earns, the difference is a loss.
Full Text
Calculating the NPV is a way investors determine how attractive a potential investment is. Since it essentially determines the present value of the gain or loss of an investment, it is easy to understand and is a great decision making tool.
When NPV is positive, the investment is worthwhile; On the other hand, when it is negative, it should not be undertaken; and when it is 0, there is no difference in the present values of the cash outflows and inflows. In theory, an investor should undertake positive NPV investments, and never undertake negative NPV investments . Thus, NPV makes the decision making process relatively straight forward.
NPV Decision Table
NPV simply and clearly shows whether a project adds value to the firm or not. It's easy of use in decision making is one of its advantages.
Another advantage of the NPV method is that it allows for easy comparisons of potential investments. As long as the NPV of all options are taken at the same point in time, the investor can compare the magnitude of each option. When presented with the NPVs of multiple options, the investor will simply choose the option with the highest NPV because it will provide the most additional value for the firm. However, if none of the options has a positive NPV, the investor will not choose any of them; none of the investments will add value to the firm, so the firm is better off not investing.
Furthermore, NPV is customizable so that it accurately reflects the financial concerns and demands of the firm. For example, the discount rate can be adjusted to reflect things such as risk, opportunity cost, and changing yield curve premiums on longterm debt.
Assign just this concept or entire chapters to your class for free.
Key Term Reference
 Opportunity cost
 Appears in these related concepts: Defining the Payback Method, The Importance of Motivation, and Defining Comparative Advantage
 cash outflow
 Appears in these related concepts: Reporting Financing Activities, Defining NPV, and Selected Financial Ratios and Analyses
 debt
 Appears in these related concepts: Debt Utilization Ratios, Deficit Spending, the Public Debt, and Policy Making, and Collection from Delinquent Payables
 discount
 Appears in these related concepts: The Discount Rate, Par Value at Maturity, and Present Value, Multiple Flows
 discount rate
 Appears in these related concepts: Discounted Cash Flow Approach, The Discount Rate, and The Federal Reserve and the Financial Crisis of 2008
 forwards
 Appears in these related concepts: Secondary Market Organizations, Types of Market Organizations, and Reporting of Financial Statement Analysis
 investment
 Appears in these related concepts: Functions of Corporate Finance, The Role of the Financial System, and GDP Equation in Depth (C+I+G+X)
 investor
 Appears in these related concepts: Advantages of Private Financing, Agency, and Financial Instruments
 present value
 Appears in these related concepts: Capital Leases vs. Operating Leases, Calculating Values for Different Durations of Compounding Periods, and Present Value and the Time Value of Money
 risk
 Appears in these related concepts: The ExportImport Bank of the United States, Approaches to Assessing Risk, and Risks Involved in Capital Budgeting
 yield
 Appears in these related concepts: Bonds Payable and Interest Expense, Stock Warrants, and Calculating the Yield of an Annuity
 yield curve
 Appears in these related concepts: The Yield Curve, Default Risk and Bond Price, and Chapter Questions
Sources
Boundless vets and curates highquality, openly licensed content from around the Internet. This particular resource used the following sources:
Cite This Source
Source: Boundless. “Advantages of the NPV method.” Boundless Finance. Boundless, 20 Sep. 2016. Retrieved 27 Sep. 2016 from https://www.boundless.com/finance/textbooks/boundlessfinancetextbook/capitalbudgeting11/netpresentvalue94/advantagesofthenpvmethod4103863/