Ch 11. Capital Budgeting and NPV (Net Present Value)

For a company to grow sustainably, it must invest in new factories, emerging technologies, or acquisitions. The process of making these long-term investment decisions is called Capital Budgeting, and the most theoretically sound criterion for it is the NPV (Net Present Value) method.

1. The Concept of NPV

NPV is the sum of the present values of all expected future cash flows from an investment, minus the initial investment cost.

NPV Formula

NPV = \sum_{t=1}^{n} \frac{CF_t}{(1+k)^t} - I_0

CFt: cash inflow in year t, k: discount rate (cost of capital), I0: initial investment

NPV > 0: Increases firm value → Accept
NPV < 0: Destroys firm value → Reject

2. Interactive NPV Simulation

Use the calculator below to experiment with how changing the cost of capital (discount rate) affects the viability of an investment.

NPV (순현재가치) 계산기

초기 투자액 (I0)

할인율 (r, %)

연도별 현금흐름 (콤마로 구분)

결과: 순현재가치 (NPV)177,037원

수락 (NPV > 0)

The Power of the Discount Rate: When the discount rate rises from 5% to 15%, NPV drops sharply even with the same cash flows. This is the logical basis for why investment slows during periods of high interest rates.

3. Advantages of the NPV Method

Time Value of Money: Precisely accounts for the difference between future and present money.
Firm Value Maximization: NPV represents the net increase in firm value, aligning directly with the goal of maximizing shareholder wealth.
Value Additivity: The NPVs of independent projects can simply be summed to find total value.

Finance is not merely about managing money — it is about “how to translate uncertainty into present value.” Use NPV as your standard for clear-headed investment judgment.

Finance Ch11. Capital Budgeting and NPV — Capturing Future Value in the Present