From the course: Accounting Foundations: Managerial Accounting

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The net present value (NPV) method

The net present value (NPV) method

From the course: Accounting Foundations: Managerial Accounting

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The net present value (NPV) method

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- Two widely-used capital budgeting techniques recognize the time value of money, the net present value method and the internal rate of return method. Both methods apply discounted cash flow principles in determining the acceptability of an investment. The net present value method uses a standard discount rate, that is the hurdle rate, to restate all cash flows in terms of present values, and then makes comparisons. In choosing a discount rate, a company's cost of capital, as well as the riskiness of a project, should be considered. If the company were considering a very high-risk project, a higher discount rate would be used because high-risk projects must yield higher than average returns in order to compensate for the increased probability of low or negative returns. The selection of the right discount rate is critical in the execution of a useful capital budgeting analysis. The net present value method compares all expected cash inflows associated with an investment with the…

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