Net Present Value
The net present value is the most commonly used method to decide whether to invest in a project or not.
The net present value of a project is equal to the sum of the present value of all after-tax cash flows from the project minus the initial investment.
The investment decision using the NPV method will be based on whether the NPV is positive or negative. The NPV will be positive if the present value of all future cash flows is higher than the initial investment. A positive NPV indicates that the project is worth investing in. On the other hand, a negative NPV indicates that investing in the project will not be wise.
The formula for calculating NPV is:
Example
A project requires an initial investment of $100 million and after that provides the following cash flows in the next four years.
Year 1: $30 million
Year 2: $30 million
Year 3: $30 million
Year 4: $50 million
Assuming a required rate of return of 10%, the NPV of this project will be calculated as follows:
Since the project has positive NPV, the project is considered worth investing in.
| Calculator Usage |
| We can solve the NPV problems using the official BA II Plus calculator as follows:Step 1: Enter Cash FlowsBefore you enter the new cash flows, clear the previous work by pressing the keys CF, 2ND, CLR WORK.Now you are ready to enter the cash flows. You should see CF0 on screen. Enter the cash flows as follows:Initial investment 100[+/-][ENTER] CF0 = -100Period 1 Cash Flow [↓][30] CF1 = 30Period 2 Cash Flow [↓][↓] [30] CF2 = 30Period 3 Cash Flow [↓][↓] [30] CF3 = 30Period 4 Cash Flow [↓][↓] [30] CF4 = 50Step 2: Enter Interest RateEnter interest rate [NPV]10[ENTER] I = 10%Step 3: Compute NPVCompute NPV [↓] [CPT] NPV = 8.756 |