What does Net Present Value mean?
The net present value is a financial calculation that, in essence, elaborates a company's cash flows. The Net Present Value will take an entity's cash flow– both incoming and outgoing flows–and combine them to yield a fundamental indicator. The net present value is a calculation used in discounted cash flow analysis; the calculation is a common method for utilizing the time value of money for appraising a long-term investment.
The net present value calculation is also used for capital budgeting purposes. Throughout finance, economics and accounting, the figure is used to measure the excess or shortfall of cash values, once financing charges are satisfied. When all future cash flows are incoming and the only outflow is represented by the purchase price, the net present value is simply the present value of the future cash flows minus the purchase price.
In general, the net present value refers to the present value of cash flows that are expected by a business model. The net present value formula is used to compare different types of investments, particularly in those situations where different investment values or different expected profits are to be expected at different times. By using the net present value of estimated investments and expected profits, a company’s investment plan can be compared evenly—this ultimately enables the company to render a decision on which investment route to proceed with.
What is a Net Present Value Calculator?
A net present value calculator calculates the present value of an annuity or investment product for a future value based on payments made at a fixed interest rate. The Net Present Value Calculator will tabulate the present value or the amount that a series of future payments is worth now. The resource is free and may be utilized at a number of financial websites.
The typical net present value calculator will require the user to satisfy five components associated with the investment. The first component of the net present value calculator requires the user to input the interest rate per period; the next component requires the user to submit the number of periods aligned with the investment. Following the input of this information, the net present value calculator requires the user to input the future value of the investment and the payment amount. Once this is accomplished enter when the payment is due; once the information has been entered, simply click on ‘calculate’ and the net present value calculator will yield the present value of the annuity or investment product.
What is the Net Present Value Formula?
Each cash inflow and outflow is discounted back to its present value, and then summed together. As a result, the net present value is the sum of all terms: R(T)/(1+i)^t. In this equation, t= the time of the cash flow, i=the discount rate or the rate of return that could be earned on an investment in the financial markets with similar variables and risk), R(t)= the net cash flow or the amount of cash, inflow minus the outflow at the time.
The discount rate will fluctuate based on the firm’s business model; a number of firm’s will use their weighted average cost of capital; however, many people believe that it is appropriate to use a higher discount rate in order to adjust for risk or other external factors.