The net present value of an investment is the present value of the investment, minus the amount of money it costs to buy into the investment. All of the investment’s cash flows must occur at the same interval for the calculation to be accurate.
- [Instructor] The net present value of an investment is the present value of the investment minus the amount of money it costs to buy into the investment. All the investment's cash flows must occur at the same interval for the calculation to be accurate. I'll show you in this movie how to calculate the basic NPV of a project. My sample file is the NPV workbook, and you can find it in the chapter two folder of your exercise files collection. The NPV function requires two arguments. The first is the rate.
This is the risk-free rate, which is the return that you could get on your investment without risk. So for example, if you run a company and you have a product line that sells very well, but you know there's more demand out there for you, you could invest in that product line and get a return of 5.75% in this case. In many cases, you will use the risk-free rate that reflects the treasury bonds for the period of time for your investment. For example, a 10-year treasury bond might return 2.8%, whereas a 30-year treasury would return 3.2%, that sort of of thing.
They're assumed to be risk-free because of the low likelihood of default from the US government. The other argument is a range of cells with a series of cash flows. You'll notice I have a period zero, an investment of minus $400,000. That's the amount of money that you are paying out. That initial investment is not included in the NPV calculation. Instead, you start with the cash flows after the investment. So you have $35,000, 85,000, and then $150,000 for periods three, four, and five.
To calculate the NPV, given all those inputs, click in cell B13, then type an equal sign, and the function we'll use is NPV, which is just short for net present value. Then after left parentheses. Click the cell that contains your rate. And we'll assume it's an annual rate, so we don't need to divide by anything. Then a comma, and then select the cash flows after the investment. So that would be B seven through B11.
The reason that you start at period one and exclude the investment is because the NPV function assumes that the cash flows start one period from now, usually one year, whereas you're making the initial investment right now. So that's why it's not included. So I have B three, my rate, and B seven through B11. Then I'll type a right parentheses. And now I need to subtract the value of the investment. In cell B six, the investment is listed as a negative number.
So to subtract it, I'll actually use the addition operation, so that would be plus B six. So my net present value is the present value of the cash flows in periods one through five minus the $400,000 at period zero. And when I press enter, I get an NPV of $69,304.45. Because it is a positive value, this is a project I should at least consider taking on.
- Calculating the effect of interest rates and inflation
- Finding the arithmetic and geometric means of growth rates
- Calculating the future and present value of an investment
- Calculating loan payments for a fully amortized loan
- Calculating the effect of paying extra principal with each payment
- Finding the number of periods required to meet an investment goal
- Calculating net present value and internal rate of return
- Building a cash tracking worksheet
- Visualizing cash flows using a waterfall chart