DETERMINING NET PRESENT VALUE (NPV) WITH WORKED EXAPMLE

Cash flow analysis

Cash flow is essentially the movement of money into and out of your business; it's the cycle of cash inflows and cash outflows that determine your business' solvency. Cash flow analysis involves examining the components of your business affecting the flow of money in the business. For instance; accounts receivable, inventory, accounts payable, credit terms etc.

Net Present Value

The Net Present Value (NPV) is a very important tool used for decision making in the mining. It is used to evaluate a project or investment’s present-day worth.

The purpose of NPV


Calculating net present value is one of the most reliable and popular method used in capital investment because it accounts for the time value of money by using discounted cash flows analysis. Before deciding to participate in a company, a company or investor usually determines the profitability of the investment. The principle of NPV is similar to that of return on investment (ROI) such that  a positive value would make for a good investment.

Hence NPV is defined as the sum of the present values (PVs) of incoming and outgoing cash flows over a period of time.

Time value of money dictates that time has an impact on the value of cash flows. Cash flows of nominal equal value over a time series result in different effective value cash flows that makes future cash flows less valuable over time. If for example there exists a time series of identical cash flows, the cash flow in the present is the most valuable. 

The NPV of an investment is determined by calculating the present value (PV) of the total benefits and costs which is achieved by discounting the future value of each cash flow. NPV is a useful tool to determine whether a project or investment will result in a net profit or a loss because of its simplicity. A positive NPV results in profit, while a negative NPV results in a loss.

NPV Calculations

Net Present Value (NPV) formula is used to determine the present value of an investment by the discounted sum of all cash flows received from the project and sums that is projected to be received in the future. The formula for NPV can be rewritten as


            Where: Co – Initial Investment, n – number of years, C – Cashflow of respective year

and NPV for respective (n) year/periods  is determined using this formula:
 For example:

The table below summarises the the projected cash flow of five years for  XY company. Determine the NPV for the respective years and the total NPV of the project.




Sample Calculations:

Firstly proceed by determining the NPV for each year using the NPV for (n) year formula:

                                                   (DF - Discount factor)
                                     (Cn)      (DF)    (n)
NPV year 0:  NPV = $100000/(1+0.1)^0          = -$100,000.00
NPV year 1:  NPV = $680727.27/(1+0.1)^1     = $ 618 842.98
NPV year 2:  NPV = $680727.27/(1+0.1)^2     = $ 477,781.57
NPV year 3:  NPV = $680727.27/(1+0.1)^3     = $ 892,641.01
NPV year 4:  NPV = $680727.27/(1+0.1)^4     = $ 531,822.33
NPV year 5:  NPV = $680727.27/(1+0.1)^5     = $ 523,606.63

Now determine the total NPV of the project over the 5 year period using:
 

Total NPV of the Project =   -$1,000,000.00-$100,000.00+$ 618 842.98+ $ 477,781.57+  $ 892,641.01+$ 531,822.33+ $ 523,606.63
 =$1,944,694.51

Remark: A positive NPV indicating the project is feasible.
DETERMINING NET PRESENT VALUE (NPV) WITH WORKED EXAPMLE DETERMINING NET PRESENT VALUE (NPV) WITH WORKED EXAPMLE Reviewed by CEDRICK KAU on March 20, 2016 Rating: 5

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