Net Present Value Npv Topics: Net present value, Investment, Rate of return / Pages: 4 (831 words) / Published: Mar 26th, 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 | \$

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.