Net Present Value (NPV)
Another time value of money concept that has to do with serial payments is net present value, or NPV . This calculation is a more complex version of the basic present value calculation mentioned earlier. Under a net present value calculation, the present value of each future cash inflow and outflow is figured. Then the results are added to determine whether, in the present, the project has a positive value or negative value for a company or investor.
For example, if a company was going to invest $10,000 today, receive $4,000 each of the next three years, and then have to pay an additional $1,000 to exit the investment, an investor or company would want to know if they’re losing money when the time value of money is considered.
Assuming an 8% annual interest rate, the calculation may look something like this, with the present values of money flowing out represented by negative numbers and money flowing in represented by positive numbers:
Cash Flows
Formula
Present Value
Initial Investment
– $10,000
– $10,000
– $10,000
Year #1 Payment
+ $4,000
+ $4,000 / (1.08)
+ $3,704
Year #2 Payment
+ $4,000
+ $4,000 / (1.08)2
+ $3,429
Year #3 Payment
+ $4,000
+ $4,000 / (1.08)3
+ $3,175
Final Investment
– $1,000
= $1,000 / (1.08)3
– $794
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