Changes

Net Present Value is a method to estimate the current value of future cash flows.

'''Net Present Value''' is a method to estimate the current value of future cash flows.

In its simplest form, Net Present Value applies a discount rate to a future cash flow number and the product is the Net Present Value.

In its simplest form, Net Present Value applies a discount rate to a future cash flow number and the product is the Net Present Value.

The discount rate may have many components; Internal Rate of Return (IRR), Cost of Capital, Cost of Debt, Risk, and so on.

The discount rate may have many components; Internal Rate of Return (IRR), Cost of Capital, Cost of Debt, Risk, estimated [[inflation]] and risk.

Let's consider a simple example.  Suppose, ignoring Shakespeare's advice I lent $100.00 each to two friends of mine, due one year from today.

Suppose you lent $100.00 to Person A.  It is to be repaid within one year.  You would like a return of 5% on your money you expect inflation to be 2%, and your assessment of risk for this person leads you to add 1% to the discount rate.  This means you would assign a discount rate of 8% to this loan.  If this person approached you suggesting, I will give you $90.00 today to discharge my loan, you would counter that you needed at least $92.59.  (92.59 x 1.08 = $100.00)

One friend calls up and asks me how much will I accept from him if he pays today.  Because I am getting currenlty getting 5.27% on my invesments, and this fiend is almost risk free (he is conservative) I tell him I will accept $95.00.  This $95.00 is the Net Present Value of the $100.00 owed to me.  The discount rate I used was my IRR.

Usually a [[corporation]] will use a Weighted Average Cost of Capital as a discount rate when NPV is the appropriate method of evaluating an investment or capital expenditure.