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# NPV Net Present Value

HP 12c Financial Calculator

Definition:

NPV is an abbreviation for Net Present Value, also known as Discounted Cash Flow or DCF.

Calculating NPV is a method for evaluating projects or investments, and is utilized in capital budgeting. It is an application of a fundamental concept in economics and finance called the Time Value of Money, which, in turn, utilizes the arithmetic of compound interest in reverse. A dollar received in the future is less valuable than a dollar received today.

The steps involved in calculating NPV are:

• Determine all cash flows associated with a project or investment and their timing (e.g., the years in which they will occur).
• These cash flows can be both negative (when money is spent) and positive (when money is received).
• Determine an appropriate interest rate, also known as a discount rate, to bring each future cash flow to its equivalent present value (PV).
• Add the PVs of all cash flows, both positive and negative.

A special application of NPV is the computation of IRR, or Internal Rate of Return, also known as a Hurdle Rate.

Also Known As: Net Present Value, Discounted Cash Flow, DCF

Examples:

In a simple case, where:

• You make an investment of \$1,000 in year 1
• The discount rate is 10%
• You expect to receive \$110 in year 2
• You expect to receive \$1,200 in year 3

The NPV of the investment would be:

• The year 1 cash flow is -\$1,000
• The PV of the year 2 cash flow = \$110/1.10 = \$100
• The PV of the year 3 cash flow = \$1,200/(1.10^2) = \$1,200/1.21 = \$991.74
• The NPV thus = -\$1,000 + \$100 + \$991.74 = \$91.74