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The net present value of an investment is the present value of the investment minus the amount of money accosted by into the investment. All of the investment's cash flows must occur at the same interval for the calculation to be accurate. In other words, if you have investments on a monthly basis, then all of them must be on a monthly basis. You calculate an investment's net present value using the NPV function. This function has two arguments: Rate, which is at the discount rate or the rate of return that you could gain from a risk-free investment, and also a range of values that contain the investment's future cash flows.
You can list up to 254 cells that contain cash flow values. As always, you should be sure to adjust the rate to account for how many times per year interest is compounded. In most cases, interest is compounded monthly, so you would divide the rate by 12. By accounting convention, if you are required to pay for the investment at the start, don't include the payment in the array of future cash flow values. Instead, you should subtract the investment amount from the total future cash flows. In keeping with standard accounting practice, you should enter the investment amount as a negative number and add each of the NPV formula's output.
Let's evaluate the two investments that I have summarized in this worksheet. To do that, we'll create an NPV formula, and we are assuming a discount rate of 4%, which is in cell B3. Because we are assuming that interest is compounded monthly, we'll divide that by 12. Now we can enter the values, the cash flows. The positive cash flows are in cells, A8 through A12. Close the parenthesis and then we add the initial investment, which is $100,000 in the cell A7.
Hit Enter and we have a net present value for this investment of $23,759.66. Now let's do the same thing for the second investment. We'll create another NPV formula. Again, we are taking our rate from B3, dividing by 12 for the number of months in a year. Our positive cash flows, cash flows to us, run from D8 to D13, and then, we add the initial investment which is -$100, 000 representing a cash flow from us.
Hit Return, and we see a net present value of $23,513.51. Because the cash flows for investment 1 generate a greater net present value, that's the investment you should go with. Now we are assuming that both investments have the same level of risk. When you use NPV to compare several investments, if all of the investments have the same level of risk, then you should go with the investments with the higher net present value.
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