Net Present Value Rule

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DEFINITION of 'Net Present Value Rule'

A rule stating that an investment should be accepted if its net present value is greater than zero and rejected otherwise. According to the theory of net present value (NPV), participating in a positive NPV project will increase firm or shareholder wealth.

BREAKING DOWN 'Net Present Value Rule'

While most firms follow the net present value rule, there are some situations where the theory is abandoned. If the company is pressured by large debt payments, some positive NPV projects will be rejected. In this case, the initial capital will go towards servicing the debt instead of investing in new projects.

If a firm has poor corporate governance, managers may ignore the net present value rule. In order to appear active, management may take on negative NPV projects to give shareholders the illusion of ongoing corporate investment.

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