Performance Management

PROJECT MANAGEMENT Net Present Value NPV (E)

What is the project? How to select and justify the project? How to plan and execute the project?

Posted: Sep 2010

When Net Present value (NPV) method is used to evaluate projects, the difference between present value of all cash incomes and the present value of all cash outflows—the net present value—determines whether or not a project is an acceptable investment.

Net present value (NPV) takes the present value of all future cash incomes and outows over the project life into account. The factors used in this method are the initial and on-going costs of the project, the life of the project, the expectd annual cost savings, and the required rate of return. Salvage value, additional investments. The formula for NPV is as follows:

If the present value of the cash flow is greater than the initial cash investment of the project (NPV has a positive value), then the project is worth engaging. This means that the value of the future cash flow is worth more than the initial investment.

If the present value of the cash flow is less than the initial cash investment ( NPV has a negative value), then the project should not be accepted from a financial perspective. This means that the value of the future cash flows does not cover the initial investment. However, in some specific cases the project may be required from a perspective of quality or regulatory requirements. In such sutuation the  NPV of the project may be irrelevant.

The present value of future cash flows is determined by multiplying the value of the net inflow by a factor representing the present value of an annuity. Finance and managerial accounting texts typically contain a table of the present value of an annuity and a partial table is presented on the next page. When the cash income is the same for each year, the average annual income and the period for analysis can be used. If this is not the case, the net flow for each year would have to be multiplied by the appropriate factor and sum of those values.

Net Present Value (NPV):

• Financial method that takes into account all three components of net cash income, time value of money, and risk.

• By having all three components present in the formula, the company is presented with a balanced view of the projects that is considered. This method to use when reviewing capital projects.

  
  

Continue on Project Management:
 
1. Project Management Overview 
2. 9 Areas of Project Management 
3. Project Lifecycle – 5 Stages of Project  
4. How to Determinine a Value of the Project? 
    4.1. Simple Payback 
    4.2. Average Return on Investment (ROI) 
    4.3. Net Present Value (NPV) 
    4.4. Internal Rate of Return (IRR) 
    4.5. Cost/benefit analysis 
    4.6. Time value of money 
    4.7. Present value of future payments 
    4.8. Justification of Addopted project 
5. Project Planning – Project Charter 
6. Work Cascading Structure (WBS) 
7. Project Scheduling ( Arrow-on-Arrow and Gantt Chart ) 
8. Project Scheduling  ( CPM and PERT ) 
9. The Responisbility Matrix 
10. Resources and Budget Planning 
11. Clasification of Projects