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Net present Value (NPV) is a key metric used by investors to calculate the attractiveness of a potential investment. Investopedia defines NPV as follows:
Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of a projected investment or project.
The following is the formula for calculating NPV:
Ct = net cash inflow during the period t
Co = total initial investment costs
r = discount rate, and
t = number of time periods
Whilst the concept of NPV is generally well understood by modellers and investors alike, it is amazing how often in our model review work we find NPV’s calculated incorrectly which have a material impact on the viability of the project (To find out more about how to model NPV try the Financial Modelling Handbook website).
The challenge is simple, based upon the simple cashflow model provided, calculate the NPV of the future pre-tax, pre-financing cashflows of the project.
- 1. Download the template model from here (or above).
- 2. Based on the cashflows in the model, found on the ‘Cashflow’ sheet, calculate the NPV as per above.
- 3. If you are brave enough, post your answer (the calculated NPV plus your decision to invest or not) as a comment otherwise you can e-mail me your answer and calculations to firstname.lastname@example.org
- 4. The winner will be selected using a complex Excel based randomiser algorithm.
- 5. The answer will be posted next week on this blog.