# Calculate Net Present Value

Net Present Value (NPV) measures the viability of a project or investment by taking into account the investments (outflow) and returns generated (inflow) from the investments. It is computed based on the sum of a series of cash flows in and out. NPV takes into account the series of cash paid or received in today's value. This is different from a layman calculation of cash flows which only takes into account the dollar value of the cash flows. For example, we take out \$1000 from our pockets to invest in a business venture. In one year's time, the business venture pays out \$1,100 and we put this money into our pocket.

To a layman, the net investment gain is \$100 (\$1,100 - \$1,000). Using NPV, the amount is smaller. This is because we take into account what our initial \$1,000 would have earned us if we put it in the bank. Assuming that the interest rate is 5%, our \$1,000 would have earned us \$1,050. Therefore the net investment gained would have been \$50 (\$1,100 - \$1,050). That's not all. The amount of \$50 is what we would have gained in one year's time. But in today's time, that \$50 would have worth less today. That means if we put less than \$50 into the bank, we would have gotten that \$50 in one year's time. The exact amount is \$47.62(\$50 / 105%). This amount is the Net Present Value of our cash out flow of \$1,000 (denoted by a negative sign) plus a cash inflow of \$1,100 in one year's time (denoted by a positive sign).

Sounds complicated? Here's another way of looking at it. That \$1,100 in one year would have a present value of \$1,047.62 (\$1,100 / 105%). Since we took out \$1,000 to gain that \$1,100 (which has a present value of \$1,047.62), the NPV is \$47.62.

After you have understood the concept, you would not have to subject yourself to this kind of calculation. You can use a time line to present the above concept and an Excel Formula to calculate the Net Present Value.

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