One of the most salient laws of finance is referred to as the time value of money. The concept states that a dollar today is worth more than a dollar tomorrow because you can invest that dollar today and make more than a dollar tomorrow. The Net Present Value (NPV) formula is based on the time value of money and is commonly used to make capital budgeting decisions. In layman's terms, the formula is used to find the present value of future cash flows. One way to calculate NPV is with Excel.
- Skill level:
- Moderately Easy
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Things you need
Determine the rate of discount (rate) over the length of one period. Let's say the discount rate is 8 per cent. This is usually equivalent to the minimum rate of return for a particular project.
Determine Value 1, Value 2, etc. Each value represents a cash payment at the end of the year. That is a project that promises £65 for the next three years will have Value 1 = £65, Value 2 = £65, and Value 3 = £65.
Determine the initial cost of the project. This is referred to as the project cost and is considered to be an outlay of funds. Let's say the project has a total cost of £130.
Calculate the NPV. Insert the formula: "=NPV(8, -200, 100, 100, 100)", where 8 is the discount rate, -200 is the initial cost or outlay, and 100 is the cash flow at the end of the next three years.
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