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
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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
 
 
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