Net Present Value (NPV): In simple words, it’s the current value of cash today which is expected to receive in future after taking inflation or return on investments into consideration. Thus, it will add value to your decision to opt for a suitable investment option where you will be able to judge the value of cash that you have today is how much worth that you are going to get after some years. Just like, if you want to by a shop, you will first estimate the future cash flows that shop would generate and then discount those cash flows into one lump-sum present value amount. Let us go by an example;

Suppose you have been proposed to invest in a project “ABC Ventures” in which you invest Rs. 20 Lacs today and from next year the project will start generating cash flows without any further investment. Just like below table which shows the money invested today and the cash flows generated in future.

Project_CashFLow

To see whether the proposal is worth going ahead or stop and recheck whether it’s even giving better returns than any bank deposits. To figure out whether this project is better than a bank FD or it’s a better weapon to beat inflation, you can calculate the Net Present Value of these cash flows as per the rate of interest your bank gives or average inflation year on year which is also called the “Discount Rate” for this purpose. Let’s assume both bank FD and Inflation grow at a rate of 8.50% p.a.. This will be termed as discount rate of 8.50% p.a.

But before that you need to know what formula should be applied to find out NPV for the suggested project; Let us see!

1. When cash inflows are even: That means when there is only one or same amount of inflows are expected

NPV Calculation (even)

In the above formula,
R is the net cash inflow expected to be received each period;
i is the discount rate;
n are the number of periods during which the project is expected to operate and generate cash inflows.

2. When cash inflows are uneven: That means when there are multiple and not equal amount of inflows are expected

NPV Calculation (uneven)

In the above formula,
i is the discount rate;
R1 is the net cash inflow expected to be received during first period;
R2 is the net cash inflow expected to be received during second period;
R3 is the net cash inflow expected to be received during third period, and so on

As per the proposed project ABC Ventures, it seems to be uneven inflows in future thus we have to use the second formula to calculate NPV for the project. See the table below;

NPV Calculation

The above calculation of NPV shows a figure which is more than “Zero”, that means you will make more than the fixed deposit gives and also its total payout is much more than letting the principal invested in an inflation linked investment. Thus, the project seems to be a better idea to invest in.

This method you can use next time when your Bank RM or Insurance agent shows some rosy figures of various payout in a particular Moneybank or Traditional Plan to compare whether the plan is better than a Fixed Deposit or PPF etc.

What is NPV (Net Present Value) and How to Calculate it?

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