The Net Present Value calculation is a technique that helps us to make better decisions based on more variables that go beyond other investment appraisal techniques. It is probably one of the most widely used techniques in professional investment appraisal. It is used when you are looking to understand if a project is viable or not. It tells us the profit generated by the project and if whether it exceeds the initial investment, taking into consideration the term in which you need your money back by and any discounts you need to apply to that income such as costs, interest or required rates of return etc.
The NPV is the difference between the cash inflows and cash outflows, discounted by a rate that the future inflows will be subject to, therefore bringing all income to today’s terms or “present value”.
The tool includes the following variables, which you need to know in order complete the calculation:
- Investment Amount
- Project Term in Years
- Discount Rate
- Cash Outflow/Investment Required
- Forecast Cash Inflows for Project Term
The way you know if whether a project is viable or not is from the output of the calculation. The NPV will calculate your result in monetary terms, that will either be more than £0 or less than £0. If it is less than £0 over the project term, then you should not progress with the project. Where however the result is a positive figure that is above £0, then the project, in theory, is positive and therefore, cashflow positive and able to pay off liabilities such as costs and return you initial investment.
I’ve created a calculator for some projects I am working on and have made it available for you to download here.
The calculator is limited to a project term of five years, as most forecasting is just guess work after that.
If you would like to level up your NPV game, you can read my blog post here about calculating your discount factor or ‘WACC’ – Weighted Average Cost of Capital.
Hope it’s useful. If you would like the calculator tailored, please email me and I’ll be happy to help.