Related Decision Rules
Present Value Rule
Most capital goods last longer than a year, therefore
the investment decision must be based on an expected
stream of income over time. Future returns must be
discounted to arrive at their present value which is then
used to evaluate the potential for investment.
Firms should know the net present value (NPV) when
deciding whether to buy a capital equipment or not.
NPV is simply the present value of the capital good
less the supply price of capital (Sk). Sk is the price the
firm has to pay to acquire the capital good. Hence, if
NPV >0, indicating that the PV of the project is greater
than the supply price, the firm can gain by investing in
the project; and vice versa.
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