TABLE OF CONTENTS The net present value (NPV) method belongs to the discounted cash flow (DCF) methods. These are methods to support the process of selection and evaluation between different courses of action, enabling decision-makers to take financial decisions. DCF methods are normative approaches as they relate decisions to necessary conditions, for example the existence of alternatives and existence of objectives, such as the long-term goals of achieving streams of benefits in the future in return for current outlays. The use of DCF methods entails the representation of the different courses of action as current and future streams of money (or, more generally, of benefits, under the criterion of the wealth maximization). These techniques enable investment decision-makers to take into account relevant variables such as: time value of money, perception of risk, forecast of inflation, and conditions for cost of capital and opportunities for alternative investments.
The main concept of DCF methods is the time value of money, i.e. money has a different value depending upon the time it is received or paid out, and hence cash flows in future time have to be discounted. Therefore the underlying concept of NPV is that if cash to be received in the future were received now, the cash could be invested to earn interest (return), or it would not be necessary to borrow money now and to pay interest (cost of capital). In addition a future cash flow bears the risk of not being...
