A popular mechanism of measuring the discounted cash flow value of the profit
| NPV = \sum_{i=0}^n \frac{R_{t_i}}{(1+r)^{t_i}} = R_0 + \sum_{i=1}^n \frac{R_{t_i}}{(1+r)^{t_i}} |
where
n | total number of time steps (usually time step is one year) |
|---|---|
t_i | time passed since the first investment ( assuming that t_0 = 0) |
r = \rm \frac{Cash_{out} - Cash_{in}}{Cash_{in}} | discount rate |
R_{t_i} = \rm Cash_{in}(t_i) - \rm Cash_{out}(t_i) | the net cash flow at time step t_i |
R_0 = - \rm Cash_{out}(t=0) | the volume of cash investment at initial time moment t_0 = 0 |
Usually t_i = t \cdot i, where t = \rm 1 \, year and i = 1,2, 3 ... is number of years past.
The main idea of NPV is that value of cash today is higher than value of cash tomorrow because immediate cash can be invested readily available investment market opportunities and start brining some profit.
NPV dictates that commercial project should not only be just profitable but instead should be on par with or more profitable than easily available investment alternatives
The corporate investment policy usually dictates that:
investment projects with negative NPV should be rejected
investment projects with higher NPV should have a financing priority over the projects with lower NPV