How the NPV of an investment project is calculated

NPV, NPV, or net present value is a key indicator in assessing the profitability of investment projects. It allows you to know in advance whether it is worth investing, which of the investment options to choose. If the indicator is above 0, then the investment will be profitable. For the calculation, it is most convenient to use the NPV function of the Excel spreadsheet editor.

 

In order to assess the profitability of investing in a project, it is important to assess in advance whether such investments will bring profit. For these purposes, in the world practice of investment analysis, the indicator of net present value, or NPV, is used.

NPV (Net Present Value) is the sum of the discounted values ​​of the flow of payments, reduced to the current date.

Reference! The NPV indicator shows the amount of money that an investor can get from an investment. It is not just the difference between costs and revenues that is determined: the calculation takes into account risks and changes in the value of money over time. Consequently, the NPV is the profit on the project, recalculated taking into account the real price of money at the date of calculation.

In the literature, NPV is often called net present value, net discounted flow, net discounted income (abbreviated as NPV).

There are three cases of using the indicator in investment analysis:

• when assessing the viability of the project and the possibility of investing in it;
• when choosing the most profitable source of investment from several options;
• when calculating the IRR.

An important point! NPV can be calculated as part of the investment analysis of large and small projects. It is equally applicable to the valuation of financial and real investments.

Formula for calculating NPV

The essence of calculating net present value looks simple outwardly: it is enough to subtract from all cash inflows all outflows within each time period, and then bring the obtained values ​​to the moment of calculation.

However, this process can only be carried out using the formula:

Based on the formula:

CF is the total cash flow for the period t;

t is the ordinal number of the period;

i is the cash flow discount rate (reduction rate);

IC is the amount of the initial investment.

An important point! If investments are poured into the project several times in the course of its implementation, then they are included in the cash inflows of the corresponding time period.

NPV Coefficient Values ​​in Investment Analysis

The result obtained by calculating the net present value indicates how promising and profitable are investments in an investment project.

A positive NPV value for equity financing means that investing in a project is more profitable than alternatively investing funds at the interest included in the calculation of the discount rate.

An important point! When choosing from several investment projects, NPV must be calculated for each of them, and then choose the option with the highest value.

Examples of calculating NPV manually and in Excel

Suppose there are two investment projects in which an investor can potentially invest his money. To select the most appropriate option, it is worth determining the net present value for each of them.

Both options assume an initial investment of RUB 1.5 million, a 20% discount rate and a 5-month investment period.

Table 2. Calculation of the net present value for Project No. 1

Index
	1 500 000 + 65 833,3 + 389 699,1 + 361 816,8 + 331 665,5 = 63 874,8

The NPV indicator was equal to 63,874.8. A positive value indicates that the project promises to grow and is suitable for effective investment.

Carrying out calculations manually is cumbersome and fraught with errors, therefore, it seems relevant to use Excel to calculate NPV.

In the spreadsheet editor, you must:

• select the financial function NPV;
• in the window that opens, specify the discount rate, the array of cash inflows and the amount of initial investments in turn.

Table 2. Calculation of the net present value for Project No. 2

	1 500 000 + 236 666,7 + 317 236,1 + 275 034,2 + 191 983,5 +173 852,7 = - 178 001

The NPV indicator turned out to be -178 001. A negative value indicates that the project is unprofitable, so it makes no sense to invest in it.

A similar calculation can be carried out using the Excel spreadsheet editor.

The detailed calculation procedure can be downloaded in Excel format.

The calculations showed that of the two projects under consideration, the first option seems to be profitable for investment, according to which the Net Present Value turned out to be higher than 0.

An important point! How to determine the discount rate? Usually, in practice, they take the highest rate on alternative investments. For example, the interest on bank deposits is 10%, the rate of the financial market is 14%, the lease of the capital used in the investment project will bring 20% ​​profitability. As a result, the discount rate is 20%.

The procedure for calculating net present value derives from the nature of this important indicator of investment analysis.

Advantages and disadvantages of the indicator

Currently, NPV is actively used in the practice of assessing the profitability of investment projects. Among the advantages of this indicator, analysts include:

• clear criteria for making an investment decision - initial investment, revenue at each stage, profitability of alternative investments;
• accounting for changes in the value of money over time;
• accounting for project risks through the use of different discount rates.

However, NPV cannot be considered an absolutely accurate coefficient. In many cases, the correct calculation of the discount rate is problematic, which is especially typical for multidisciplinary projects. In addition, the calculation does not take into account the likelihood of the outcome of each of the projects.