3.8 Net present Value

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Net present (NPV)

used in order to work out the present value of the return on an investment

How much return on an investment is worth in today’s term
Uses discount factors which can be based on either inflation or interest rates
- Higher NPV = better

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NPV formula

Sum of present values - original cost

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advantages of NPV

More accurate method that takes a long-term view into account

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Disadvantages of NPV

Ignores timing of cash inflows and prone to forecasting errors when considering seasonal factors
Calculations are based on a projects useful lifespan which might be a pure guess