Examples of NPV (Net Present Value)
Net Present Value (NPV) refers to the dollar value derived by deducting the present value of all the cash outflows of the company from the present value of the total cash inflows and the example of which includes the case of the company A ltd. where the present value of all the cash outflows is $100,000 and the present value of the total Cash inflows is $120,000, so the net present value will be $20,000 ($120,000 – $100,000)
The following NPV examples (Net Present Value) provides an outline of the most common investment decisions. It is impossible to provide a complete set of examples that address every variation in every situation since there are thousands of such projects with Net Present Value analysis. Each example of the NPV states the topic, the relevant reasons, and additional comments as needed
The net present value is the difference between the present value of future cash inflow and the present value of cash outflow over a period of time. NPV is widely used in capital budgetingCapital BudgetingCapital budgeting is the planning process for the long-term investment that determines whether the projects are fruitful for the business and will provide the required returns in the future years or not. It is essential because capital expenditure requires a considerable amount of funds.read more and to know the profitability of the project.
- If the Net present value is positive, then the project should be accepted. It indicates that earning from the project is more than the amount invested in the project, so the project should be accepted.
- If the Net present value is negative, then it indicates that the project in which we invested the money does not provide a positive return, so the project should be rejected.
Mathematically, NPV FormulaNPV FormulaNet Present Value (NPV) estimates the profitability of a project and is the difference between the present value of cash inflows and the present value of cash outflows over the project’s time period. If the difference is positive, the project is profitable; otherwise, it is not.read more is represented as,
Where
- i stands for the Required Rate of ReturnRequired Rate Of ReturnRequired Rate of Return (RRR), also known as Hurdle Rate, is the minimum capital amount or return that an investor expects to receive from an investment. It is determined by, Required Rate of Return = (Expected Dividend Payment/Existing Stock Price) + Dividend Growth Rateread more or Discount Rate
- t stands for Time or Number of Period
Examples of Net Present Value (NPV)
Let’s see some simple to advanced examples of Net present value to understand it better.
Example #1
Company A ltd wanted to know their net present value of cash flow if they invest 100000 today. And their initial investment in the project is 80000 for the 3 years of time, and they are expecting the rate of return is 10 % yearly. From the above available information, calculate the NPV.
Solution:
Calculation of NPV can be done as follows,
NPV = Cash flows /(1- i)t – Initial investment
= 100000/(1-10)^3-80000
NPV = 57174.21
So in this example, NPV is positive, so we can accept the project.
Example #2
In 2nd example, we will take the example of WACC (weighted average cost of capital) for calculating the NPV because, in WACC, we consider the weight of equity and debt also the cost of equity and debt. Calculate the NPV.
Solution:
Company XYZ Ltd provides the following detail regarding their project for 10 years.
Free cash flow to the firm is given below over a period of time. And WACC is 15 %
Calculation of NPV can be done as follows,
NPV =1104.55
In this example also Net present value is positive, so we can, or we should accept the project
Example #3
Maruti is in the business of auto and ancillary, and they want to start their subsidiary business as an expansion plan for assembling the auto part, so they had provided the below information for calculating the NPV. They want to know should this project will be feasible or not.
- Cost of equity – 35%
- Cost of debt – 15%
- The weight of equity – 20%
- The weight of debt – 80 %
- Tax rate – 32%
- Cash flow is given below for 7 year
- 2010= -12000
- 2011=10000
- 2012=11000
- 2013=12000
- 2014=13000
- 2015=14000
- 2016=15000
Find the NPV with the help of WACC.
Solution:
Calculation of WACC can be done as follows,
WACC formulaWACC FormulaThe WACC Formula is a way of evaluating a firm's cost of capital in which each category is weighted proportionately. It is the average rate that a company is expected to pay to its stakeholders in order to finance its assets. In simple terms, it is the minimum return that the firm should earn on its existing asset base in order for investors and lenders to be interested, so as to avoid them from investing elsewhere.read more = We*Ce+Wd*Cd*(1-tax rate)
= 20*35+80*15*(1-32)
WACC = 15.16%
Calculation of NPV can be done as follows,
NPV = 29151.0
In this example, we are getting a positive net present value of future cash flows, so in this example also we will accept the project.
Example #4
Toyota wants to set up one new plant for expansion of current business, so they want to check the feasibility of the project. Toyota had provided the following information regarding cash flows and WACC. Cash flow during the period is as follows.
- 2008 = -4000
- 2009= -5000
- 2010= 6000
- 2011=7000
- 2012=9000
- 2013= 1200
Solution:
Calculation of NPV can be done as follows,
NPV = 12348.33
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This has been a guide to NPV Examples. Here we learn how to calculate NPV (Net Present Value) step by step with the help of practical examples. You may learn more about financing from the following articles –
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