What is NPV and how to calculate it?

The net present value (NPV) is calculated so that we know the present value of an investment, as well as its profitability.

The calculation of the net asset value is carried out by updating all the cash flow of an investment to the current value, using a discount rate in the calculation known as the Minimum Attraction Rate (TMA).

The formula to calculate the NPV is as follows:

FC = cash flow
TMA = minimum attraction rate
j = period of each cash flow

In this formula we have a sum that updates each of the cash flow values ​​that generate cash inflows for the investor, subtracted from the initial investment.

NAV calculation example

Let’s calculate, for example, an investment made at a cost of $ 15,000.00 and that returns annual cash flows at values ​​of $ 3,500.00 for 5 years. The investor considers that his minimum attraction rate is 4% per year.

By aggregating each cash flow using negative values ​​for the outflows and positive values ​​for the inflows, we get:

Period (j)Cash flow (FC)VPN formulaUpdated cash flow
0$ – 15,000.00-15,000 / (1 + 0.04)  0$ -15,000.00
1$ 3,500.003,500 / (1 + 0.04)  1$ 3,365.38
two$ 3,500.003,500 / (1 + 0.04)  2$ 3,235.95
3$ 3,500.003,500 / (1 + 0.04)  3$ 3,111.49
4$ 3,500.003,500 / (1 + 0.04)  4$ 2,991.81
5$ 3,500.003,500 / (1 + 0.04)  5$ 2,876.74
NAV = $ 581.38

With this value, we know that with a minimum attraction rate of 4%, the investment is viable, since it generates profitability with a positive NPV.

Meaning of NPV and IRR value

When an investor looks at whether or not a project is paying to invest, he can use the NAV calculation in conjunction with a minimum attraction rate, which is the minimum that he proposes to get out of a project.

When calculating a NPV, we see how much the capital of an investment is worth in the present, as in the previous example where we see that the entry of $ 3,500.00 in 5 years, considering a rate of 4%, is equivalent today to $ 2,876.74, that is, , cost less.