Advantages of the Net Present Value Method Essay

a. Advantages of the Net Present Value Method
The Net Present Value approach to capital management and appraisal is one of the most commonly used methods in evaluating viable investments and projects. Net present value is the present value of the stream of future cash flows from a project less the project's net investments. There are various benefits associated with the use of the NPV approach to capital appraisal. First, the method considers all the cash flows as opposed to other techniques like the payback period method. For this reason, it proves to be a more reliable technique to evaluation of the project throughout its lifetime (Peterson-Drake, P. & Florida Atlantic University, 2014, p. 1).
The second benefit of the NPV method is that it considers the time value money. Discounting tells the actual value of money at a given point in timer, adjusted for inflationary factors. For this reason, the method appears to be more realistic compared to non-discounted methods of project capital appraisal. The NPV method is also associated with the advantage of taking into account the risks of future cash flows. This is catered for through the cost of capital. This way, the NPV criteria becomes more predictable and helps to make the most effective investment decisions. Finally, NPV tells whether the investment will increase the value of the firm. From the final net present value obtained, a high positive value implies possibility of the investment increasing the value of the firm (Peterson-Drake, P. & Florida Atlantic University, 2014, p. 1).
b. The Payback Period Method and Net Present Value Methods
Payback Period Method
Payback Period Method
Year 0 Year 1 Year 2 Year 3 Year 4
Revenue 0 25000000 27500000 30800000 34188000
Profit 0 2500000 2750000 3080000 3418800
Depreciation 0 95000 95000 95000 95000
Net Cash Flow -8000000 2405000 2655000 2985000 3323800
Payback 2405000 5060000 8045000 11368800
From the payback period analysis, the cumulative sum of all the net cash flows indicates that the initial amount invested will be realized in the third year of investment. Therefore, through the project's life, the amount invested will be realized in the course of this third year. The investor should, therefore, consider making the investment since it is profitable and the returns will be worth the amount put into the invested cost. From the fourth year, the cash flows will represent the overall benefits that have been realized on top of the entire cost of the project.
Net Present Value (NPV) Method
Net Present Value Method
Year 0 Year 1 Year 2 Year 3 Year 4 NPV
Revenue 0 25000000 27500000 30800000 34188000
Profit 0 2500000 2750000 3080000 3418800
Depreciation 0 95000 95000 95000 95000
Net Cash Flow -8000000 2405000 2655000 2985000 3323800
PVIF 1 0.926 0.857 0.794 0.735
Present Value -8000000 2227030 2275335 2370090 2442993 1315448
The net present value is a positive value (1315448) and this means that the project is worth pursuing. This means that there are positive net discounted returns out of the project