# Net Present Value Npv

Pages: 6 (831 words) Published: March 26, 2012
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 5 = \$2000 * (1 + .1)–5 = \$1242
NPV = \$3201

Return On Investment
= (Discounted Benefits – Discounted Costs) / Discounted Costs

Project A
= (\$9747-\$7427) / \$7427 = .31 or 31%...

References: Schwalbe, K (2001). Information Technology Project Management 2nd edn. Course Technology (division of Thompson learning): Canbridge, MA.
Petty, J & Peacock, R (2000) Financial Management 2nd edn. Prentice Hall: Paramus, NJ.