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Because each period produces equal revenues, the first formula above can be used.

Net Present Value Analysis In Capital Budgeting | Cotton Farming

Both projects require the same initial investment, but Project X generates more total income than Project Y. However, Project Y has a higher NPV because income is generated faster meaning the discount rate has a smaller effect. Net present value discounts all the future cash flows from a project and subtracts its required investment. The analysis is used in capital budgeting to determine if a project should be undertaken when compared to alternative uses of capital or other projects.

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Net Present Value Explained in Five Minutes

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Compare Investment Accounts. The present value of net cash flows is determined at a discount rate which is reflective of the project risk. In most cases, it is appropriate to start with the weighted average cost of capital WACC of the company and adjust it up or down depending on the difference between the risk of the specific project and average risk of the company as a whole.

The first step involved in the calculation of NPV is the estimation of net cash flows from the project over its life. The second step is to discount those cash flows at the hurdle rate. The net cash flows may be even i.

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When they are even, present value can be easily calculated by using the formula for present value of annuity. However, if they are uneven, we need to calculate the present value of each individual net cash inflow separately.

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Once we have the total present value of all project cash flows, we subtract the initial investment on the project from the total present value of inflows to arrive at net present value. In the above formula, R is the net cash inflow expected to be received in each period; i is the required rate of return per period i. When net cash flows are uneven , i. Where, i is the hurdle rate also called discount rate ; R 1 is the net cash inflow during the first period; R 2 is the net cash inflow during the second period; R 3 is the net cash inflow during the third period, and so on These formulas ignore the effect of taxes and inflation.

In case of standalone projects, accept a project only if its NPV is positive, reject it if its NPV is negative and stay indifferent between accepting or rejecting if NPV is zero. In case of mutually exclusive projects i.

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Assume that the salvage value of the project is zero. Round your answer to nearest thousand dollars.