Why use a net present value calculator? Why is a NPV calculation useful?
Unlike the IRR or MIRR calculations that express results in percentage terms, the NVP calculation reveals its results in dollar terms. A dollar amount can be very beneficial.
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What is net present value?
In finance jargon, the net present value is the combined present value of both the investment cash flow and the return or withdrawal cash flow. To calculate the net present value, the user must enter a "Discount Rate." The "Discount Rate" is simply your desired rate of return (ROR).
Using the NPV Calculator
In addition to the projected cash flow, the user sets five values.
- Initial Investment (-): The first amount invested. You enter money invested as a negative number. (You are writing a check.)
- Discount Rate: The rate-of-return you want to earn on your investment.
- Initial Investment Date: The start date.
- First Cash Flow Date: The dates in the cash flow grid start from this date.
- Cash Flow Frequency: Use cash flow frequency to initial set the dates in the cash flow grid. You may change as many dates as you want when you enter the cash flows.
You must enter at least one negative value and one positive value (investment return); otherwise, the NPV calculator cannot calculate a result.
How is NPV useful?
As I've mentioned, you can use the NPV calculation to determine if you should invest. All other things being equal, the larger the result, the better the investment. You can use the result to evaluate a single investment, or you can use it to compare investments.
But what if you are negotiating an investment?
Wouldn't it be handy to have a tool to that tells you by how much you can raise your bid and still meet your investment objective?
The NPV calculation is that tool.
The NPV is the calculation investors use to learn if they are paying too much for an investment (or if they could pay more) relative to the rate of return they want to earn. If the net present value is negative, the initial investment is too high for the investor to meet their goal ROR. If the NPV is positive, the investor can pay that amount more for the investment, and they'll still earn what they want to make.
Here's an example....
Sharon invests in already issued mortgages. She can buy a mortgage for $210,000 that has 200 remaining monthly payments of $1,682.77 each. The next payment is due on Oct. 1. Sharon wants to earn 6% on her investments.
Is this a good deal for Sharon?
Follow these steps.
- Click "Reset" to clear entries in the cash flow table.
- Enter -210,000.00 for the "Initial Investment."
- Enter Sharon's personal "Discount Rate" i.e. 6% — the ROR she wants to earn on her investments.
- Set "Initial Investment Date." In this case, that's the date Sharon plans to purchase the mortgage. Use Sept. 15 if you are following along.
- Set "First Cash Flow Date" to Oct. 1.
- Set "Cash Flow Frequency" to monthly.
- Click on "Add Series." Create 200 monthly entries of $1,682.77 starting on Oct. 1.
- Click "Calc":
- Net Present Value = $5,248.61
- Internal Rate of Return = 6.376%
Since the IRR equals 6.4%, Sharon will earn more than the 6% she desires.
But what if there is a competing bid for the mortgage?
Can Sharon pay more than $210,000?
Yes! She can pay as much as $5,248.61 more and still earn a rate-of-return of 6.0%.
How does she know this?
What's the proof?
Let's see for ourselves. Change the "Initial Investment" to $-215,248.61 ($210,000.00 plus the NPV result from above) and click "Calc" again. Now we have:
- NPV = $0.00
- IRR = 6.0%
Sharon now knows how much more she can invest if needed and still achieve her goal of a 6.0% return.
Note: When the NPV is negative, that is the amount the investor must decrease their initial investment by to make their desired ROR.
Calendar Tip: When using the calendar, click on the month at the top to list the months, then, if needed, click on the year at the top to list years. Click to select a year, select a month and select a day. Naturally, you can scroll through the months and days too. Or you can click on "Today" to quickly select the current date.
If you prefer not using a calendar, single click on a date or use the [Tab] key (or [Shift][Tab]) to select a date. Then, as mentioned, type 8 digits only - no need to type the date part separators. Also, because the date is selected, you do not need to clear the prior date before typing. If your selected date format equals mm/dd/yyyy, then for Dec. 1, 2016, type 12012016.