Net Present Value (NPV) Chapter 21. Net Present Value (NPV) We're going to invest cash now with high hopes of a large future return. But will the anticipated payback be enough to cover our initial investment given the pro- ject's high risk? Further, would any of our alternative projects provide us with a bet- ter nancial return? Answering these ques- tions is the essence of capital budgeting, and net present value (NPV) analysis provides "gold standard" answers. The NPV of a proposed project is the value of future cash benets minus costs, all restated in terms of today's money. In NPV analysis, relevant cash inows and outows are discounted to compute the present value for each and then added. The resultant NPV is an estimate of how much the project will increase the wealth of the company. spreadsheets. The hardest part of an NPV analysis is estimating the right cash ows to use in the formulas. The very foundation of NPV analysis is the accurate forecasting of cash ows asso- ciated with a capital project. These pro- forma cash ow projections answer the questions "What initial investment will be required for this project?" and then "How will this project impact the company's future total cash ows?" But beware: Application of these con- cepts and formulas without understanding their limits will often lead to erroneous and misleading results. Also, the mistaken impression of accuracy given by computa- tion of overly precise variables can give a false condence in proforma projections. And don't forget strategy. No matter how high an NPV, if a company's strategies are defective, its capital investment projects