Net present value looks at all cash flows for a project over the project's useful life to determine if a company should commence with the project. If the net present value is more than £0, then the project will make a return above what the company wants to make and the company should commence with the project. As an example for net present value, a firm wants to add a tractor. The company expects the tractor to last three years and has a cost of £6,500. The firm wants a 10 per cent return and over the three years believes it will save £2,925 a year after all applicable taxes.
- Skill level:
- Moderately Easy
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Determine the cash flows on a yearly basis for the project. In our example, today there is a £6,500 cash outflow and then in years 1, 2 and 3 there is a £2,925 cash inflow each year.
Use the Present Value of 60p Table and find all applicable present value factors. In our example, use 10 per cent and years 1, 2, and 3, so the factors are 0.90909, 0.82645, and 0.75131 respectively.
Multiply the each cash flow by the applicable present value factor. In our example, £65,000 times 1 equals £65,000, £2,925 times 0.90909 equals £2,659.0, £2,925 times 0.82645 equals £2,417.30, £2,925 times 0.75131 equals $,3380.90.
Add together the positive cash flows and the negative cash flows to determine the projects net present value. In our example, £2,659.0 plus £2,417.30 plus £2,197.50 minus £6,500 equals £741.50. The projects creates positive cash flow.
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