The net present value formula calculates NPV, which is the difference between the present value of cash inflows and the present value of cash outflows, over a period of time. Net present value (NPV) determines the total current value of all cash flows generated, including the initial capital investment, by a project. Let us study the net present value formula using solved examples.
The net present value formula finds application in estimating which projects are likely to generate great profits. Thus the formula can be expressed as:
NPV can also be calculated by finding the difference between the Present Value(PV) after the competition of time duration of investment and the initial amount invested where the Present Value "PV" after time "t" for a rate of return "r" can be calculated as:
There are certain signs that are used in the net present value formula that determine whether the investment is good or bad. They are as follows:
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Example 1: An investor made an investment of $500 in property and gets back $570 the next year. If the rate of return is 10%. Calculate the net present value.
Solution:
Amount invested = $500
Money received after a year = $570
Rate of return = 10% = 0.1
Using net present value formula,
Net Present Value = $518.18 − $500.00 = $18.18
Therefore, for 10% rate of return, investment has NPV = $18.18.
Example 2: Sam bought a house for $750,000 and sells it a year later for $990,000, after deducting any realtor's fees and taxes. Calculate net present value, if the rate of return is 5%.
Solution:
Investment on buying the house = $750,000
Monet received from sale a year later = $990,000
Rate of return = 5% = 0.05
Using net present value formula,
Net Present Value = $942,857.143 − $750,000 = $192,857.143
Therefore, for 5% rate of return, investment has NPV = $192,857.143
Example 3: If the rate of return is 5%, what would be the net present value of a box of fruits with the price at $20,000 and a year later it costs $45,000.
Solution: Given,
Current price of box = $20,000
Year later = $45,000
Rate of return = 5% = 0.05
Using the net present value formula,
PV = 45000/(1 + 0.05) 1
PV = 42857.15( please check)
Net present value = 42857.15 - 20,000 = 22857.15
Therefore, the net present value is $22857.15
The net present value formula calculates NPV, which is the difference between the present value of cash inflows and the present value of cash outflows, over a period of time. The net present value formula finds application in estimating which projects are likely to generate great profits.
The formula to calculate the net present value is:
NPV can also be calculated by finding the difference between the Present Value(PV) after the competition of time duration of investment and the initial amount invested where the Present Value "PV" after time "t" for a rate of return "r" can be calculated as:
The three important rules to keep in mind while calculating the net present value is:
