Net present value is a financial metric commonly used by financial analysts to evaluate project proposals or investment decisions. Mathematically, it is the difference between the present value of cash inflows and the present value of cash outflows. Inflows are usually defined as income and outflows are usually defined as costs. As the calculation is difficult to do by hand, analysts use calculators (either online or financial) to determine the base-case NPV for a project. The base NPV is the average case scenario. Financial analysts will then calculate a best case (lower costs, higher income) and worst case (higher costs, lower income) to provide management with additional data points.
Step 1
Determine your variables. Define your required discount rate (required rate of return in order to accept the project) and the length of the project or asset ownership (in years).
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Step 2
Determine the cost of the investment. This can be one initial cash outlay or multiple cash outlays. Sum for a total cost of investment.
Step 3
Project the income or annual cash flows for every year of the project investment.
Step 4
Go to the NPV calculator provided by Investopedia or use your own financial calculator. Enter the variables as defined above and click calculate for a base-case NPV. Adjust income up and/or initial costs down for a best-case scenario. Adjust income down and/or initial costs up for a worst-case scenario. In a financial calculator the cash flow payments are PMT, n is the number of years and i is the discount rate.
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