Cash Flow
cash flowThe net present value (NPV) is used for capital budgeting, or by investors to analyze the profitability of an investment project or plan.
In case the NPV result of a project or investment is a positive number, that's mean the project or the investment will be positive.
Formula:
| Rt |
| (1 + i)t |
NPV = Net present value
Rt = Net cash flow at time t
i = Discount rate
t = Time of the cash flow
Profitability index formula:
| PV of future cash flows |
| Initial Investment |
PV means present value
For example, the initial investment is $1,000,000 with a constant monthly cash flow of $25,000 for five years, and assuming the discount rate is 8% calculate NPV.
First the annual discount rate needs to be turned into a periodic or monthly rate, because we have monthly cash flow.
So periodic rate = (1 + 0.08)(1 ÷ 12) - 1 = 0.64%
| 25,000 |
| (1 + 0.0064)1 |
| 25,000 |
| (1 + 0.0064)2 |
| 25,000 |
| (1 + 0.0064)3 |
| 25,000 |
| (1 + 0.0064)4 |
| 25,000 |
| (1 + 0.0064)5 |
Profitability index (PI) is
| 1,241,122.58 |
| 1,000,000 |