Microsoft Office Tutorials and References
In Depth Information
If the NPV is positive, this indicates that the future cash flows provide a better rate of return than the specified
discount rate. The positive amount returned by NPV is the amount that the investor could add to the initial cash
flow (called Point 0 ) to get the exact rate of return specified.
As you may have guessed, a negative NPV indicates that the investor does not get the required discount rate, of-
ten called a hurdle rate. To achieve the desired rate, the investor would need to reduce the initial cash outflow
(or increase the initial cash inflow) by the amount returned by the negative NPV.
The discount rate used must be a single effective rate for the period used for the cash
flows. Therefore, if flows are set out monthly, you must use the monthly effective rate.
Definition of NPV
Excel's NPV function assumes that the first cash flow is received at the end of the first period.
This assumption differs from the definition used by most financial calculators, and it is
also at odds with the definition used by institutions such as the Appraisal Institute of
America (AIA). For example, the AIA defines NPV as the difference between the present
value of positive cash flows and the present value of negative cash flows. If you use Ex-
cel's NPV function without making an adjustment, the result will not adhere to this
definition.
The point of an NPV calculation is to determine whether an investment will provide an appropriate return. The
typical sequence of cash flows is an initial cash outflow followed by a series of cash inflows. For example, you
buy a hot dog cart and some hot dogs (initial outflow) and spend the summer months selling them on a street
corner (series of inflows). If you include the initial cash flow as an argument, NPV will assume the initial in-
vestment isn't made right now but instead at the end of the first month (or some other time period).
Figure 12-1 shows three calculations using the same cash flows: a $20,000 initial outflow, a series of monthly
inflows, and an 8% discount rate.
The formulas in row 9 are as follows:
B9: =NPV(8%,B4:B8)
C9: =NPV(8%,C5:C8)+C4
D9: =NPV(8%,D4:D8)*(1+8%)
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