November 21, 2024

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Net Present Value (NPV) explained #Finance

Net Present Value (NPV) explained #Finance


Net Present Value explained in a clear and simple way, in just a few minutes! Two steps: first understanding the idea of present value and future value, and then Net Present Value. Present Value and Future Value are closely related concepts. An example of Future Value is: How much money

will I have one year from now if I invest $100 at an expected 20% annual return? $100 multiplied by 1.2 is $120. An example of Present Value is: How much money do I invest today to achieve $120 one year from now at an expected 20% annual return? $120 divided by 1.2 is $100. So to get to the future

value, you move from left to right: take a present value, and multiply it by 1 plus the rate of return. To get to the present value, you go from right to left: take a future value, and divide it by 1 plus the rate of return. You can do this for multiple years as well. How much money will I have two

years from now if I invest $100 at an expected 20% annual return? $100 multiplied by 1.2 is $120. This $120 in turn multiplied by 1.2 is $144. How much money do I invest today to achieve $144 two years from now at an expected 20% annual return? $144 divided by 1.2 is $120. Then divide the $120 once

again by 1.2 to get to $100 today. The formula for future value is $100 times 1.2 to the power 2, equals $144. In other words, present value times 1 plus the rate of return to the power of the number of years, equals future value. The formula for present value is $144 divided by 1.2 to the power 2,

equals $100. In other words, future value divided by 1 plus the rate of rate of return (to the power of the number of years), equals present value. Let’s perform a Net Present Value calculation step-by-step. What is the present value (PV) of all the cash inflows and cash outflows of the following

project? The project is expected to provide four years’ worth of benefits of nominally $400 per year, and an investment today of $1000 to launch the project. What is the present value of a $400 benefit that we expect one year from now? Take the nominal amount of $400 and divide it by 1 + the

weighted average cost of Capital. Weighted average cost of Capital (or WACC) is a calculation of a firm’s cost of Capital in which each category of Capital is proportionately weighted. We take a fairly high WACC of 20% in

this calculation. 1 + 20% equals 1.2. $400 divided by 1.2 equals $333. The present value of a nominal amount of $400 one year from now is $333 as today’s equivalent. What is the present value of a $400 benefit that we expect two years from now? To calculate that present value, we need to take the

nominal amount of $400 and divide it by 1 + 20%, to the power 2 (as we need to take two steps: from year 2 to year 1, from year 1 to today). This is the same as saying $400 divided by 1.2 * 1.2, or $400 divided by 1.44, which is $278. Next we calculate the present value of the $400 benefit that we

expect three years from now, and the present value of the $400 benefit that we expect four years from now. We have now translated all Cash Flows into today’s equivalent. To get to NPV, you now simply sum the amounts: $333 + $278 + $231 + $193 minus $1000 investment today. The Net

Present Value is $35. The word “Net” in the term “Net Present Value” means deducting the investment amount from the present values of the future Cash Flows. As the net present value of this project is positive, it is worth pursuing. Accept the project proposal, as it

creates value for the company. If the net present value of the project would have been negative, it would not be worth pursuing. Reject the project proposal, as it does not create value for the company. The main idea of Net Present Value is very simple: time is money! The net present value method

takes the time value of money into account, by translating all future Cash Flows into today’s money, and then adding up today’s investment and the present values of all future Cash Flows. Want to learn more about business and

href="https://cashnews.co/finance" style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance? Then subscribe to the Finance Storyteller YouTube channel! Thank

you.

Now that you’re fully informed, watch this insightful video on Net Present Value (NPV) explained.
With over 577756 views, this video is a must-watch for anyone interested in Finance.

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49 thoughts on “Net Present Value (NPV) explained #Finance”

  2. Ive been studying economics, business and finance for 5 years since i was in high school till now and ive had many teachers teach me this. But the way i understood it now more then ever in 5 minutes is crazy

  3. I don't understand why we use discount rate ? What are we discounting ? And how can one arrive at a discount rate ? How do we calculate it to find it ( discount rate ) ourselves ?

    Not in this example you did but we usually take it into account right ? Present Value ( benefits ) – Present Value ( cost ) = NPV of the project

    But we use in excel sheet formula discount rate then select each year's value.

  5. Npv is the difference of cash outflow today for starting up the project and the present value of all the cash inflow that project generate💚
    Npv= investment – present value of cash inflow.

  12. Wow, i happy to have watched this video. No teacher and textbook has explained it better than you Sir! Explained in a nice and simple way. I will never forget this again. Menzi from South Africa.

  16. You forgot to explain in the first place how you arrived at 1.2 – I don’t know how so nothing made sense to me 🤷‍♂️ I’m stupid but so is anyone just starting their journey in finance

  20. I am now more confused. I don't understand the concept. I see numbers that yield a return but if you follow the graph far enough they do not. Help.

  21. After watching two videos the whole night, the following morning I decided to revisit this NPV & I came across your video, OMG easiest explanation ever!!!!🥰

  24. This is why teachers over the world are in such a noble profession. When you take any concept and explain it in such detail but with such ease of understanding – it is such a beautiful thing.

  26. A firm needs component in an assembly operation. If it wants to do the manufacturing itself, it would need to buy a machine for Rs. 400,000 which will last for 4years with no salvage value. Manufacturing costs in each of the 4 years would be Rs. 600,000, Rs. 700,000, Rs. 800,000, and Rs. 1 million respectively. If the firm had to buy the components from a supplier, the cost would be Rs. 0.9 million, Rs. 1 million, Rs. 1.1 million and Rs. 1.4 million respectively in each of the four years. However, the machine would occupy floor space which would have been used for another machine. This latter machine would be hired at no cost to manufacture an item, the sale of which would produce net cashflows in each of the four years of Rs. 0.2 million. It is impossible to find room for both the machines and there are no other external effects. The cost of capital is 10% and the present value factor for each of the four years is 0.909, 0.826, 0.751 and 0.683 respectively.

    Should the firm make the components or buy from outside?

    What will be the solution?

  34. So the difference between NPV AND PV is that NPV is basically the net ammount of costs and return profit from mutliple years and PV is just the ammount invested at the start? Also I dont really understand your slogan saying time is money. I get it obviously but not how it applies to NPV. Were calculating the costs so we can see if we make profit by investing into this company. But what does time have to do with it? It's just about the cost and profit ammounts no?

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