Foundations of finance
Lectures 3: Investment decision rules
Techniques to compare between different investment decisions:
The Net Present Value Rule:
AS the name states NPV calculates the present value of all the cash flows occurring in the
future by discounting them back at a given rate. The project is accepted if the NPV is
positive and rejected if the NPV is negative.
Consider a project in which there is an initial cash outflow in year 0 and then inflow of C1,
C2 and C3 respectively in year 1,2 and 3. If r id the discounting rate then the NPV of the
project would be:
𝐶1 𝐶2 𝐶3
𝑁𝑃𝑉 = −𝐶0 + + +
(1 + 𝑟) (1 + 𝑟)2 (1 + 𝑟)3
Therefore the NPV and the discounting rate have a negative relationship for
conventional projects.
If the expected cash flow constitute a perpetuity :
𝐶
𝑁𝑃𝑉 = −𝐶0 +
𝑟
Where C0 represents the initial cash outflow and C represents the cash inflows that occur
forever.
NPV and discount rate:
Lectures 3: Investment decision rules
Techniques to compare between different investment decisions:
The Net Present Value Rule:
AS the name states NPV calculates the present value of all the cash flows occurring in the
future by discounting them back at a given rate. The project is accepted if the NPV is
positive and rejected if the NPV is negative.
Consider a project in which there is an initial cash outflow in year 0 and then inflow of C1,
C2 and C3 respectively in year 1,2 and 3. If r id the discounting rate then the NPV of the
project would be:
𝐶1 𝐶2 𝐶3
𝑁𝑃𝑉 = −𝐶0 + + +
(1 + 𝑟) (1 + 𝑟)2 (1 + 𝑟)3
Therefore the NPV and the discounting rate have a negative relationship for
conventional projects.
If the expected cash flow constitute a perpetuity :
𝐶
𝑁𝑃𝑉 = −𝐶0 +
𝑟
Where C0 represents the initial cash outflow and C represents the cash inflows that occur
forever.
NPV and discount rate:
