The calculation of the net present value (NPV) is a budgeting technique that equates the discounted cash flows against the initial investment. The mathematical formula is:
FV = Future cost of the cash inflows,
I = Initial Investment
k = Discount rate equal to the owner’s cost of capital
I will demonstrate with an example. Let’s say a project represents a series of cash flows that looks like this:
|Year||Cash Inflows||Present Value
(at 10% discount rate)
|Present Value of cash inflows (Total)||$8,722|
|Net Present Value||($1,278)|
In this hypothetical example, each of the cash flows discounted to the present will not recover the initial investment, and this investment should not be made.
- If the Net Present Value is greater than zero, accept the project.
- If the Net Present Value is less than zero, decline the project.