The manager or analyst collects relevant information in the market and uses it to estimate monetary costs and benefits realized by a project. They include payback period tools and the net present value method. Both decision-making tools are comprised of logical sequence processes and steps that enable a manager or another person or institution to choose the project to undertake. The decision-making tools require information. Therefore, before a manager decides to use any of the decision-making tools, he or she should ensure that the information on costs and benefits concerning projects under consideration are available. The available information is processed and the net values obtained. The net values computed aid the manager to rank independent projects from those with the highest positive values to those with the least values. Those with the highest net values are chosen for implementation. The selection of projects is based on cost efficiency and benefit efficiency.
The first decision-making tool is the net present value. Net present value is a capital budgeting decision method used to select independent projects for business or non- business entities. According to Brigham and Houston (2007), the net present value is a direct measure of how much the projects will contribute to its shareholders in future time as compared to the present. Net Present Value method is computed using the discounted cash flows. The total discounted cash flows are the Net Present Value. The formula for calculating the net present value is as follows:
According to Madura and Fox (2007), if the net present value is less than zero (NPV<.0), the project under consideration would make losses. Therefore, it would reduce the value of the organization in the end and may be rejected. The manager would not consider it as a priority investment. If the net present value is equal to zero (NPV=0), the project under consideration would neither make losses nor make profits.