Microsoft Office Tutorials and References

In Depth Information

**Chapter 29: NPV and IRR—Evaluating Capital Investments**

CHAPTER
29

NPV and IRR—Evaluating Capital

Investments

Financial functions in Excel are used to evaluate the financial profitability and

effectiveness of investment projects. Most financial procedures involve several

payments over the course of carrying out a project, rather than a single payment at a

specific point. Using the Time Value of Money functions allows you to compare

these projects to each other. For example, when financing an asset, the investor will

receive future cash flows at different dates in the future. Excel allows you to calculate

these financial indicators of investments (NPV

—

Net Present Value, FV

—

Future

Value, IRR

Internal Rate of Return), which makes it possible to choose the most

favorable and gainful investment.

—

THETIMEVALUEOFMONEY

NPV

Net Present Value

Net Present Value is an approach/procedure used in long-term capital investment

budgeting, where the present value of cash inflows is subtracted from the present

value of cash outflows. In other words: The process of calculating the value of an

investment by adding the present value of expected future cash flows to the initial

cost of the investment. NPV is used to analyze the profitability of an investment/

project. NPV compares the value of a dollar today versus the value of that same

dollar in the future, taking inflation and return into account. When the NPV of a

project is positive, it should be accepted. When it is negative, the project should be

rejected because cash flows will be negative.

Calculating the NPV for n periods you will be applying:

—

2

3

n

¼

þ

=ð

þ

Þþ

=ð

þ

Þ

þ

=ð

þ

Þ

þ

=ð

þ

Þ

ð

:

Þ

NPV

CF
0

CF
1

1

r

CF
2

1

r

CF
3

1

r

CF
t

1

r

29

1

Excel NPV—Net Present Value Function

When using the NPV function, keep in mind that the function
does not
take into

consideration the initial investment at time 0. You will have to subtract it from the

result (add the initial investment if it has a minus sign in front of it; in other words, if