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NPV = Net Present Value
It takes cash flows over a course of years and discounts them using a discount rate. Normally it is the cost of capital plus a comfort level.
Any NPV that is positive over the time period of review means that the endeavor delivers at least the rate of return defined by the NPV discount rate. The more positive the NPV the larger the margin the endeavor beats the discount hurdle rate. (This is easily done using a simple excel spreadsheet and using the appropriate function, NPV)
Discounted Cash flow is the best means to evaluate endeavors as it takes into account the largish outlay and then discount future cash flows as future money is worth less in real world terms then money inthe pocket today. (Takes into account inflation and interest that could have been accrued for examples)
Other means of evaluting endeavors include IRR (Internal Rate of Return) which takes cash flows and calculates the equivalent discount rate to make the future discounted cash flows equal the initial cash outlays. In this case the IRR is roughly equivalent to a return rate. (Typically this is also a good measure but one needs to be cognizant that if there are a number of negative cashflows there maybe a a number of solutions wherein the sum of the DCC = 0. )
As for building in uncertainty of success being built into the NPV calcualtions it all comes down to the familiarity with the market, familiarity with the development cycle etc. and then assigning the appropriate risks possibily doing a sensitivity analysis using best and worst case scenarios.
Og
It takes cash flows over a course of years and discounts them using a discount rate. Normally it is the cost of capital plus a comfort level.
Any NPV that is positive over the time period of review means that the endeavor delivers at least the rate of return defined by the NPV discount rate. The more positive the NPV the larger the margin the endeavor beats the discount hurdle rate. (This is easily done using a simple excel spreadsheet and using the appropriate function, NPV)
Discounted Cash flow is the best means to evaluate endeavors as it takes into account the largish outlay and then discount future cash flows as future money is worth less in real world terms then money inthe pocket today. (Takes into account inflation and interest that could have been accrued for examples)
Other means of evaluting endeavors include IRR (Internal Rate of Return) which takes cash flows and calculates the equivalent discount rate to make the future discounted cash flows equal the initial cash outlays. In this case the IRR is roughly equivalent to a return rate. (Typically this is also a good measure but one needs to be cognizant that if there are a number of negative cashflows there maybe a a number of solutions wherein the sum of the DCC = 0. )
As for building in uncertainty of success being built into the NPV calcualtions it all comes down to the familiarity with the market, familiarity with the development cycle etc. and then assigning the appropriate risks possibily doing a sensitivity analysis using best and worst case scenarios.
Og
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