Microsoft Office Tutorials and References
In Depth Information
Chapter 12: Discounting and Depreciation Formulas
Figure 12-2: An initial investment returns positive future cash flows.
The NPV is negative, so this analysis indicates that buying the snowplow is not a good
investment. Several factors that influence the result:
h First, I defined a “good investment” as one that returns 10% when I set the discount rate.
If you settle for a lesser return, the result might be satisfactory.
h The future cash flows are generally (but not always) estimates. In this case, the potential
plow owner assumes increasing revenue over the ten-year life of the equipment. Unless
he has a ten-year contract to plow snow that sets forth the exact amounts to be received,
the future cash flows are educated guesses at how much money he can make.
h Finally, the initial investment plays a significant role in the calculation. if you can get the
snowplow dealer to lower his price, the ten-year investment may prove worthwhile.
No initial investment
You can look at the snowplow example in a different way. In the previous example, you knew the
cost of the snowplow and included that as the initial investment. The calculation determines
whether the initial investment would produce a 10% return. You can also use NPV to tell what
initial investment is required to produce the required return. That is, how much should you pay for
the snowplow? Figure 12-3 shows the calculation of the NPV of a series of cash flows with no
The NPV calculation in cell B20 uses the following formula: