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

initial investment.

The NPV calculation in cell B20 uses the following formula:

=NPV($B$3,B8:B17)+B7