Use in Decision Making
NPV is an indicator of how much value an investment or project adds to the firm. With a particular project, if is a positive value, the project is in the status of positive cash inflow in the time of t. If is a negative value, the project is in the status of discounted cash outflow in the time of t. Appropriately risked projects with a positive NPV could be accepted. This does not necessarily mean that they should be undertaken since NPV at the cost of capital may not account for opportunity cost, i.e., comparison with other available investments. In financial theory, if there is a choice between two mutually exclusive alternatives, the one yielding the higher NPV should be selected.
| If... | It means... | Then... |
|---|---|---|
| NPV > 0 | the investment would add value to the firm | the project may be accepted |
| NPV < 0 | the investment would subtract value from the firm | the project should be rejected |
| NPV = 0 | the investment would neither gain nor lose value for the firm | We should be indifferent in the decision whether to accept or reject the project. This project adds no monetary value. Decision should be based on other criteria, e.g., strategic positioning or other factors not explicitly included in the calculation. |
Read more about this topic: Net Present Value
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