The document discusses net present value calculations and discounted cash flow analysis. It explains that depreciation is not deducted when calculating present value because it is not a cash outflow. Discounted cash flow methods automatically account for return of the original investment. The appropriate discount rate to use is a company's cost of capital, which represents the average return required by creditors and shareholders. The net present value method calculates the present value of cash inflows, outflows, and subtracts outflows from inflows to determine if a project should be accepted. An example is provided of a company determining if a 5 year contract should be accepted using net present value analysis.

1. Recupero Investimento
Iniziale
(Metodo del Valore Attuale Netto)

2. Recovery of the Original Investment
Depreciation is not deducted in computingDepreciation is not deducted in computing
the present value of a project because . . .the present value of a project because . . .
It is not a current cash outflow.It is not a current cash outflow.
Discounted cash flow methodsDiscounted cash flow methods automaticallyautomatically
provide for return of the original investment.provide for return of the original investment.
Depreciation is not deducted in computingDepreciation is not deducted in computing
the present value of a project because . . .the present value of a project because . . .
It is not a current cash outflow.It is not a current cash outflow.
Discounted cash flow methodsDiscounted cash flow methods automaticallyautomatically
provide for return of the original investment.provide for return of the original investment.

3. Choosing a Discount Rate
• The firm’sThe firm’s cost of capitalcost of capital isis
usually regarded as the mostusually regarded as the most
appropriate choice for theappropriate choice for the
discount rate.discount rate.
• The cost of capital is theThe cost of capital is the
average rate of return theaverage rate of return the
company must pay to itscompany must pay to its
long-term creditors andlong-term creditors and
stockholders for the use ofstockholders for the use of
their funds.their funds.

4. The Net Present Value Method
To determine net present value we . . .To determine net present value we . . .
Calculate the present value of cashCalculate the present value of cash
inflows,inflows,
Calculate the present value of cashCalculate the present value of cash
outflows,outflows,
Subtract the present value of the outflowsSubtract the present value of the outflows
from the present value of the inflows.from the present value of the inflows.

5. General decision rule . . .
The Net Present Value Method

6. Let’s look atLet’s look at
how we usehow we use
present value topresent value to
make businessmake business
decisions.decisions.
The Net Present Value Method

7. Lester Company has been offered a five year
contract to provide component parts for a
large manufacturer.
The Net Present Value Method

8. • At the end of five years the working capitalAt the end of five years the working capital
will be released and may be usedwill be released and may be used
elsewhere by Lester.elsewhere by Lester.
• Lester Company uses a discount rate ofLester Company uses a discount rate of
10%.10%.
Should the contract be accepted?Should the contract be accepted?
• At the end of five years the working capitalAt the end of five years the working capital
will be released and may be usedwill be released and may be used
elsewhere by Lester.elsewhere by Lester.
• Lester Company uses a discount rate ofLester Company uses a discount rate of
10%.10%.
Should the contract be accepted?Should the contract be accepted?
The Net Present Value Method

9. Annual net cash inflows from operations
The Net Present Value Method

10. The Net Present Value Method

11. The Net Present Value Method
Present value of an annuity of $1
factor for 5 years at 10%.
Present value of an annuity of $1
factor for 5 years at 10%.

12. Present value of $1
factor for 3 years at 10%.
Present value of $1
factor for 3 years at 10%.
The Net Present Value Method

13. Present value of $1
factor for 5 years at 10%.
Present value of $1
factor for 5 years at 10%.
The Net Present Value Method

14. Accept the contract because the project has a
positivepositive net present value.
The Net Present Value Method

15. Quick Check Data
Denny Associates has been offered a four-year contract to
supply the computing requirements for a local bank.
• The working capital would be released at the end of the
contract.
• Denny Associates requires a 14% return.

16. Quick Check 
What is the net present value of the contract
with the local bank?
a. $150,000
b. $ 28,230
c. $ 92,340
d. $132,916
What is the net present value of the contract
with the local bank?
a. $150,000
b. $ 28,230
c. $ 92,340
d. $132,916

17. What is the net present value of the contract
with the local bank?
a. $150,000
b. $ 28,230
c. $ 92,340
d. $132,916
What is the net present value of the contract
with the local bank?
a. $150,000
b. $ 28,230
c. $ 92,340
d. $132,916
Quick Check 