Net Present Value Npv
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 | $
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.