Net Present Value Npv
Essay by Greek • March 26, 2012 • Essay • 1,819 Words (8 Pages) • 1,985 Views
Examples Of Net Present Value (NPV), ROI and
Payback Analysis
Introduction
Terms and Definitions
Net Present Value - Method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.
Discount Rate - Also known as the hurdle rate or required rate of return, is the rate that a project must achieve in order to be accepted rather than rejected.
Return on Investment - Expected income divided by the amount originally invested
Payback Analysis - The number of years needed to recover the initial cash outlay.
Formulas
Net Present Value = t=1..n A * (1+r)-t OR t=1..n A/ (1+r)t
Where A = Cash flow
r = Required rate of return
t = year of cash flow
n = the nth year
Return On Investment = (Discounted Benefits - Discounted Costs) / Discounted Costs
Payback Period = Years taken to repay initial outlay .
Eg. Project Z Outlay = $ 4000
Yearly cash flows = $2000
Payback period = 2yrs
Examples
* Required rate of Return = 10%
Project A Year 1 Year 2 Year 3 Year 4 Year 5 Total Total Discounted
Benefits $ - $2,000.00 $ 3,000.00 $ 4,000.00 $ 5,000.00 $14,000.00 $ 9,743.00
Costs $ 5,000.00 $1,000.00 $ 1,000.00 $ 1,000.00 $ 1,000.00 $ 9,000.00 $ (7,427.00)
Cash Flow $ (5,000.00) $1,000.00 $ 2,000.00 $ 3,000.00 $ 4,000.00 $ 5,000.00 $ 2,316.00
Project B Year 1 Year 2 Year 3 Year 4 Year 5 Total
Benefits $ 1,000.00 $2,000.00 $ 4,000.00 $ 4,000.00 $ 4,000.00 $15,000.00 $ 10,783.00
Costs $ 2,000.00 $2,000.00 $ 2,000.00 $ 2,000.00 $ 2,000.00 $10,000.00 $ (7,582.00)
Cash Flow $ (1,000.00) $ - $ 2,000.00 $ 2,000.00 $ 2,000.00 $ 5,000.00 $ 3,201.00
Net Present Value
Project A
Year 1 = -$5000 * (1 + .1)-1 = -$4545
Year 2 = $1000 * (1 + .1)-2 = $826
Year 3 = $2000 * (1 + .1)-3 = $1503
Year 4 = $3000 * (1 + .1)-4 = $2049
Year 5 = $4000 * (1 + .1)-5 = $2484
NPV = $2316
Project B
Year 1 = -$1000 * (1 + .1)-1 = -$909
Year 2 = $ 0 * (1 + .1)-2 = $0
Year 3 = $2000 * (1 + .1)-3 = $1503
Year 4 = $2000 * (1 + .1)-4 = $1366
Year
...
...