Question

Explain the five steps used in NPV analysis.

Answer 1

Net Present value of one of the most used method of capital budgeting analysis.Net present value is calculated by discounting the future cash flows and then subtracting the initial investment from sum of present value of future cash flow.

The steps used in NPV analysis is mention below:

1. Determine the initial Investment which includes cost of equipment, installation cost and working capital requirement in project.

2. Determine future operating cash flow provided by project.

3. Determine discount rate that must be adjusted with risk level of project.

4. Calculate present value of future cash flow using determined discount rate and substract initial investment from present value of future cash flows.

5. If present value of future cash flow is higher than Initail Investment then project should be accepted else it should be rejected.