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In Depth Information
Chapter 12: Discounting and Depreciation Formulas
Figure 12-6: The NPV function can include an initial value and a terminal value.
The following formula indicates that at a $360,000 asking price, the discounted positive cash at
the desired rate of return is $68,214.11:
The resulting positive NPV means that the investor can pay the asking price and make more than
his desired rate of return. In fact, he could pay $68,214.11 more than the asking price and still
meet his objective.
Although the typical investment decision may consist of an initial cash outflow resulting in
periodic inflows, that’s certainly not always the case. The flexibility of NPV is that you can have
varying amounts, both positive and negative, at all the points in the cash flow schedule.
In this example, a company wants to roll out a new product. It needs to purchase equipment for
$475,000 and will need to spend another $225,000 to overhaul the equipment after five years.
Also, the new product won’t be profitable at first but will be eventually.
Figure 12-7 shows a worksheet set up to account for all of these varying cash flows. The formula
in cell E19 is
The positive NPV indicates that the company should invest in the equipment and start producing
the new product. If it does, and the estimates of gross margin and expenses are accurate, the
company will earn better than 10% on its investment.