Net Present Value

We have discussed the Net Present Value (NPV) concept in the discussion of the IRR, as it was defined as the discount rate that renders the NPV of all the investment’s cash flow equal to zero.

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As a measure of investment performance, the NPV is the present value of all cash flows associated with the investment over its holding period discounted at the investor’s required rate of return. If the NPV is greater than zero then it mean’s that the investment return exceeds the investor’s required rate of return; if it is negative then it means that the investment will provide a return lower than the required return by the investor. The formula for estimating the NPV of a cash-flow stream discounted at a discount rate or required rate of return d is:

NPV = CF0 + CF1/(1+d) + CF2/(1+d)² +…+ CFn/(1+d)ⁿ

Example

CF0 = - 200,000
CF1 = 120,000
CF2 = 720,000
CF3 = - 150,000
Discount Rate (d) = 12%

NPV = -200,000 + 120,000/1.12 + 720,000/(1.12)² - 150,000/(1.12)³ = -200,000 + 107,142.86 + 573,979.59 – 106,767.04 = 374,355.41

In our example, the cash flow stream has a significantly higher than 0 value indicating that the investment’s return is considerably higher than the discount rate of 12% used. If the NPV came out negative it would mean that the project has an expected return below the 12%.

This is an excerpt from the 30-page e-book "Real Estate Return Mathematics".

Return from Net Present Value to Investment Analysis

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