Implications of Additive Properties of Net Present Value (NPV)
Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.
The purpose of the NPV is to help analysts and managers decide whether or not new projects are financially viable.
Followings are the implications of additive properties of NPV –
- It takes into account the time value of money.
- It considers the cash flow stream in its entirety.
- It squares neatly with the financial objective of maximization of the wealth of stockholder. The net present value represents the contribution to the wealth of stockholders.
- The net present value of various projects, measured as they are in today’s rupees, can be added. For example, the present value of package consisting of two projects A and B will simply be the sum of the net present value of these projects individually: NPV (A+B) = NPV (A) + NPV (B).
- The additive property of net present value ensures that a poor project (one which has a negative net present value) will not be accepted just because it is combined with a good project (which has a positive net present value).