NPV Function

What is NPV function?

Formula=NPV (rate, Value1, Value2.....)

Mathmetical Definition

Net present value, NPV, is a standard method for the financial appraisal of long-term projects. It's usually used for calculating capital budgets. It measures the excess or shortfall of cash flows in terms of present value. NPV can be defined as the present value of net cash flows.

What Does NPV Mean

You can treat NPV as an indicator of how much value an investment adds to the value of the firm. It helps a firm to decide on whether to buy a capital or not.

3 Possible Outcomes:

1. If NPV is less than 0, that means the investment would not add value to the firm and the project should be rejected.


2. If NPV is greater than 0, that means the investment would add value to the firm and the project can be accepted.


3. If NPV is equal to 0, that means the investment would neither gain nor lose value for the firm and the project would add no monetary value.
   
   

Formula=NPV(Rate, Value1, Value2.....)

Rate = Required rate of return

Rate is the rate used to discount future cash flows to the present values. It's also called the discount rate, which is a financial concept based on the future cash flow in lieu of the present value of the cash flow. The concept of a discount rate differs from an interest rate. The divisor in the interest rate formula is the orgininal investment, but the divisor in the discount rate formula is the resultant future value. It is the key variable of the NPV function. Using the discount rate in NPV calculation allows you to compare between 2 projects.

Next, is another part of the NPV function NPV(Rate, Value1, Value2.....)

Value1, value2, ... are 1 to 254 arguments representing the payments and income.

• Value1, value2, ... must be equally spaced in time and occur at the end of each period.
  
• NPV uses the order of value1, value2, ... to interpret the order of cash flows. Be sure to enter your payment and income values in the correct sequence.
  
• Arguments that are numbers, empty cells, logical values, or text representations of numbers are counted; arguments that are error values or text that cannot be translated into numbers are ignored.
  
• If an argument is an array or reference, only numbers in that array or reference are counted. Empty cells, logical values, or text in the array or reference are ignored.

Remarks

The NPV investment begins one period before the date of the value1 cash flow and ends with the last cash flow in the list. The NPV calculation is based on future cash flows.

• If the payment occurs at the beginning of the first period, you don't include the initial cost as one of the values.
  
• If the payment occurs at the end of the first period, you include the initial cost as one of the values .

Here is an example from our Excel project:

Example 1: You don't include the initial cost as one of the values, because the payment occurs at the beginning of the first period.

Example 2: You include the initial cost as one of the values, because the payment occurs at the end of the first period.