What is the net present value decision rule in capital budgeting?

The net present value (NPV) decision rule in capital budgeting is a financial evaluation method used to determine the profitability of an investment project. It states that an investment should be accepted if the NPV is positive and rejected if the NPV is negative.

The NPV is calculated by discounting the expected cash flows of the project to their present value using a predetermined discount rate. The discount rate is typically the company's cost of capital or the required rate of return.

If the NPV is positive, it indicates that the project's expected cash inflows are greater than the initial investment and the discounted cash outflows. This implies that the project is expected to generate more value than it costs, resulting in an increase in the company's overall wealth.

On the other hand, if the NPV is negative, it suggests that the project's expected cash inflows are insufficient to cover the initial investment and the discounted cash outflows. This indicates that the project is not expected to generate enough value to justify its costs, resulting in a decrease in the company's overall wealth.

Therefore, the net present value decision rule in capital budgeting states that projects with a positive NPV should be accepted as they are expected to increase the company's value, while projects with a negative NPV should be rejected as they are expected to decrease the company's value.