What are the implications of having a negative NPV?

A negative Net Present Value (NPV) indicates that the projected cash flows from an investment, when discounted back to their present value, fall short of the initial investment cost. This suggests that the investment is expected to lose value, meaning that it is not generating enough returns to justify the risks and costs associated with it. Therefore, the decision to pursue an investment with a negative NPV typically leads to the conclusion that it should not be undertaken.

In corporate finance, a positive NPV is desirable because it indicates potential profitability. When an investment has a negative NPV, it suggests that the opportunity cost of capital is not being met, and resources could be better allocated elsewhere. Thus, pursuing a project with a negative NPV could lead to a decrease in shareholder wealth. This makes proceeding with such an investment counterproductive for the firm’s financial health.

In contrast, options suggesting profitability or future potential to break even misinterpret the implications of a negative NPV. An investment that breaks even or is projected to be profitable would have a positive or zero NPV rather than a negative one. Hence, the understanding that a negative NPV signals the need to forgo the investment aligns accurately with standard corporate finance principles.