Financial Modeling Tutorials
- Financial Modeling Basics
- What is Financial Modeling?
- Financial Modeling in Excel
- Types of Financial Models
- Financial Modeling Interview Questions
- Alibaba IPO Financial and Valuation Model
- Box IPO Modeling Details
- Box IPO Valuation Model
- Download Alibaba IPO Financial Model
- Financial Modeling Books
- Financial Modeling Templates
- Financial Modeling Course
- Excel Modeling
- Financial Functions in Excel
- Sensitivity Analysis in Excel
- Time Value of Money
- Future Value Formula
- Present Value Factor
- Perpetuity Formula
- Annuity vs Perpetuity
- Internal Rate of Return (IRR)
- NPV vs XNPV
- NPV vs IRR
- NPV Formula
- IRR vs ROI
- Break Even Point
- Payback Period & Discounted Payback Period
- Payback period Formula
- Discounted Payback Period Formula
- Profitability Index
- Cash Burn Rate
- Simple Interest
- Effective Interest Rate
- Loan Amortization Schedule
- Rule of 72
- Geometric Mean Return
- Real Rate of Return Formula
- Continuous compounding Formula
- Weighted average Formula
- Holding Period Return Formula
- Cost Benefit Analysis
- Mortgage APR vs Interest Rate
Net Present Value Formula
Net present value is used mainly for making investment decisions. How would one understand whether an investment is good enough? NPV will help you decide.
Here’s the Net Present Value NPV formula (when cash arrivals are even):
NPVt=1 to T = ∑ Xt/(1 + R)t – Xo
- Xt = total cash inflow for period t
- Xo = net initial investment expenditures
- R = discount rate, finally
- t = total time period count
The NPV formula (when cash arrivals are uneven):
NPV = [Ci1/ (1+r)1 + Ci2/(1+r)2 + Ci3/(1+r)3 + …] – Xo
- R is the specified return rate per period;
- Ci1 is the consolidated cash arrival during the first period;
- Ci2 is the consolidated cash arrival during the second period;
- Ci3 is the consolidated cash arrival during the third period, etc…
Example of Net Present Value Formula
Let’s take a simple example to illustrate net present value formula.
Hills Ltd. would like to invest in a new project. The company has the following information for this new investment –
- Cost of the new investment as of now – $265,000
- The project will receive cash inflows as follows –
- Year 1 – $60,000
- Year 2 – $70,000
- Year 3 – $80,000
- Year 4 – $90,000
- Year 5 – $100,000
Find out the NPV and conclude whether this is a worthy investment for Hills Ltd. Assume the rate of return as 10%.
By using the above information, we can easily do the NPV Calculation of the new investment.
Cash Inflows from Investments = $60,000/1.1 + $70,000/1.1^2 + $80,000/1.1^3 + $90,000/1.1^4 + $100,000/1.1^5
= 54,545.5 + 57,851.2 + 60,105.2 + 61,471.2 + 62,092.1 = 296,065.2
Net Present Value = Cash Inflows from Investments – Cost of Investments
Or, Net Present Value = $296,065.2 – $265,000 = $31,065.2
From the above result, we can be sure that this is a worthy investment; because the NPV of this new investment is positive.
Using NPV Formula for Valuation – Alibaba Case Study
Alibaba will generate $1.2 billion of free cash flows in March’19. As we note below that Alibaba will generate a predictable positive Free Cash Flows.
- Step 1 here is to apply NPV formula to calculate the present value of FCFF explicit period
- Step 2 is to apply NPV formula to calculate PV of the terminal value
Sum total of the NPV Calculation in step 1 and 2 gives us the total Enterprise Value of Alibaba.
Below is the table that summarizes Alibaba’s DCF Valuation output.
Explanation of Net Present Value Formula
The NPV formula has two parts.
- The first part talks about the cash inflows from investments. When an investor looks at an investment, he is presented with the projected future values of the investments. He then can use the present value method [i.e. PV = FV / (1 + i) ^n, where PV = Present Value, FV = Future Value, I = interest (cost of capital), and n = number of years] to discount the future values and find out the cash inflows from the investments at the present date.
- The second part talks about the cost of investments of the project. It means how much an investor has to pay for the investments at the present date.
If the cost of investments is lesser than the cash inflows from the investments, then the project is quite good for the investor since he is getting more than what he is paying for. Otherwise, if the cost of investments is more than the cash inflows from the investments, then it’s better to drop the project since the investor has to pay more than what he is paying as of now.
Use of NPV Formula
By using this NPV formula, the investors find out the difference between the cash inflows from the investments and the cost of investments.
If the difference is positive, it’s a great project. If the difference is negative, it’s not worthy for the investors.
It is used for making prudent business decisions for the following reasons –
- First of all, NPV formula is very easy to calculate. Before making any decisions regarding investments, if you know how to calculate NPV; you will be able to make better decisions.
- Secondly, it compares the present value of both cash inflow and cash outflow. As a result, the comparison provides the right perspective for the investors to make the right decision.
- Thirdly, NPV offers you a conclusive decision. After calculating this, you will directly get to know whether to go for the investments or not.
Net Present Value – NPV Calculator
You can use the following NPV Calculator
|Net Present Value Formula =|
Net Present Value in Excel (with excel template)
Let us now do the same example above in Excel.
This is very simple. You need to provide the two inputs of Cash Inflows from Investments and Cost of Investments.
You can easily calculate the NPV in the template provided.
Step 1 – Find the present value of the cash inflows
Step 2 – Find the sum total of the present values
Step 3 – NPV Calculation = $296,065.2 – $265,000 = $31,065.2
You can download this net present value template here – Net present Value Excel Template
This has been a guide to Net Present Value Formula, practical examples, and NPV calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –