Net Present Value
Present value is the value today of a future sum of money or stream of payments. Present value is calculated by taking the future amount and applying a given discount rate, which usually represents an expected or required rate of return. This process is referred to as “discounting to present value.” To calculate present value, use the following equation:
For example, to find the present value of $100 to be paid in five years at a 5% discount rate, we would calculate 100 / (1.05)5 = $78.35.
Net present value (NPV) is a method of evaluating proposed investments, projects, or capital expenditures. NPV represents the net sum of the present values of all future cash flows, minus the purchase price or investment amount, over some time horizon.
Where:
Ct = net cash inflow during the period t
Co = total initial investment costs
r = discount rate
t = number of time periods
∑ = the sum of
For example, the projected cash flows for a three-year forecasted period are, respectively, $10 million, $12 million, and $14 million. The discount rate for the period is 5%, and the original investment amo