Let's start with a question, how should we make financial decisions?
Well, a reasonable answer might be to undertake those actions that create value.
Value for those affected by the decision, value for
the owners of a firm, for example, but which actions create value?
And while that's a complicated question, a sort of general answer that seems
reasonable would be to consider actions in which the benefits exceed the costs.
But here's a little wrinkle.
What if the costs and benefits arrive at different times?
Well, actually we're well equipped to deal with that wrinkle because we can compare
the present value of the the benefits to the present value of the costs.
See, because by computing the present value we know that the discount rate
R will adjust both for the timing and the risk of the cash flows.
So that brings us to our first lesson
which is that the NPV Decision Rule,
that is NPV which stands for Net Present Value, NPV.
The NPV decision rule says that we should accept all projects with a positive NPV
and reject all projects with a negative NPV.