$

%

Cash Flow

cash flowYear 1: $

The 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:

NPV =R _{t}(1 + i) ^{t}NPV = Net present value

R_{t}= Net cash flow at time t

i = Discount rate

t = Time of the cash flowProfitability index formula:

PI =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%NPV = -1,000,000 + [25,000 (1 + 0.0064) ^{1}+25,000 (1 + 0.0064) ^{2}+25,000 (1 + 0.0064) ^{3}+25,000 (1 + 0.0064) ^{4}+

+ ...] = -1,000,000 + 1,241,122.58 = 241,122.5825,000 (1 + 0.0064) ^{5}Profitability index (PI) is

PI =

= 1.2411,241,122.58 1,000,000

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