Series 79: 3.5.9.2. Net Present Value

Taken from our Series 79 Online Guide

3.5.9.2. Net Present Value

An investment may often involve more than one payment. In fact, many investments generate multiple cash flows over time. A concept related to the time value of money that has to do with serial payments is net present value (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:

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	Cash Flows	Present Value
Initial Investment	– $10,000	– $10,000
Year #1 Payment	+ $4,000	+ $3,704
Year #2 Payment	+ $4,000	+ $3,429
Year #3 Payment	+ $4,000	+ $3,175
Final Investment	– $1,000	– $794
Net Cash Flows	+ $1,000
Net Present