Arizona State University (ASU) ACC241 Uses of Accounting Information II Exam 3 Practice

The net present value (NPV) of an investment is calculated as the present value of the cash flows generated by the investment minus the initial investment cost. This approach allows investors to determine whether the expected returns on an investment exceed its cost.

When assessing an investment, it’s important to consider the time value of money, which is why only the present value of future cash inflows is relevant. By subtracting the initial investment from the present value of those cash flows, investors can evaluate the profitability of the investment. If the NPV is positive, it indicates that the investment is expected to generate more value than it costs, making it a potentially good option. If it’s negative, the investment is expected to result in a net loss.

This understanding underlies financial decision-making, enabling investors to make informed choices based on the present value of future benefits compared to their costs.