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Net Present Value Net Present Value Formula Net Present Value (NPV) is a formula used to determine the present value of an investment by the discounted sum of all cash flows received from the project. The formula for the discounted sum of all cash flows can be rewritten as Net Present Value Alternative Formula When a company or investor takes on a project or investment, it is important to calculate an estimate of how profitable the project or investment will be. In the formula, the -C0 is the initial investment, which is a negative cash flow showing that money is going out as opposed to coming in. Considering that the money going out is subtracted from the discounted sum of cash flows coming in, the net present value would need to be…show more content…
Solution Step 1: Prepare a table to calculate discounted cash flow of each period by multiplying the actual cash flows by present value factor. Create a cumulative discounted cash flow column. Year n | Cash Flow CF | Present Value Factor PV$1=1/(1+i)n | Discounted Cash Flow CF×PV$1 | Cumulative Discounted Cash Flow | 0 | $ −2,324,000 | 1.0000 | $ −2,324,000 | $ −2,324,000 | 1 | 600,000 | 0.9009 | 540,541 | − 1,783,459 | 2 | 600,000 | 0.8116 | 486,973 | − 1,296,486 | 3 | 600,000 | 0.7312 | 438,715 | − 857,771 | 4 | 600,000 | 0.6587 | 395,239 | − 462,533 | 5 | 600,000 | 0.5935 | 356,071 | − 106,462 | 6 | 600,000 | 0.5346 | 320,785 | 214,323 | Step 2: Discounted Payback Period = 5 + |-106,462| / 320,785 ≈ 5.32 years Advantages and Disadvantages Advantage: Discounted payback period is more reliable than simple payback period since it accounts for time value of money. It is interesting to note that if a project has negative net present value it won't pay back the initial investment. Disadvantage: It ignores the cash inflows from project after the payback period NPV = FV + (PV1) + (PV2) + (PV3) + (PV4) + (PV5) (1+ r) n1 (1+ r) n2 (1+ r) n3 (1+ r) n4 (1+ r) n5 Discounted Payback Period One of the major disadvantages of simple payback period is that it ignores the time value of money. To
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