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Subject 4. NPV Profiles
A NPV profile is a graph showing the relationship between a project's NPV and the firm's cost of capital. The point where a project's net present value profile crosses the horizontal axis indicates a project's internal rate of return.
Some observations:
- The IRR is the discount rate that sets the NPV to 0.
- The NPV profile declines as the discount rate increases.
- Project A has a higher NPV at low discount rates, while Project B has a higher NPV at high discount rates. The NPV profiles of Project A and B join at the crossover rate, at which the projects' NPVs are equal.
- The slope of Project A's NPV profile is steeper. This indicates that Project A's NPV is more sensitive to changes in the discount rates.
User Contributed Comments 5
You need to log in first to add your comment.| poomie83: So when the npv crosses beyond the irr horizontal line does that mean npv is less than zero? |
| sagrr: yes, if you choose discount rate above (horizontally) where NPV crosses the horizontal axis, NPV will be less than zero. In this case, for example, for A, a discount rate above 11.8% would result in a negative NPV |
| bear1234: I was under the impression that NPV can not be less than zero |
| jonan203: bear1234 - NPV can be any positive or negative value, in practice a project which yields a NPV that is negative would not be selected |
| darnoor871: This was much easier to understand than the book. Straight forward and to the point. |