Question

Why are firms market caps so much higher if a firm’s NPV is negative?

Answer 1

At any point of time, the NPV of firm is the difference between the present value of its inflows and outflows. A positive NPV is indicator that the inflows are greater than outflows signifying profits and a positive growth prospects. A negative NPV signifies that the present value of outflows is greater than inflows and that there is a possible need for funds in future to keep the firm going.

The firms market value is the product of the price of the company issues shares and the number of shares outstanding. The number of outstanding shares is a generally less volatile as it depends on less frequent activities like IPO and buybacks etc. The volatile component is the price of stock which varies evry trading day at every second depending on the stock and market related parameters.

Thus if the NPV is negative, at this point the expected expenses of the firm is more than the income generated. This can be bad if the investors or the market perceives this firm to have less growth potential and thus the price of stock may decrease causing market capitalization to decrease. But I the investors and market expects the firm to do better and as having good growth potential, inspire of having a negative NPV, the price of stock can increase increasing the market capitalization.

Thus NPV and market capitalization are 2 different concepts which can move in the same or opposite manner depending ding on other parameters like growth potential of firm and markets perception.