MODULE 6: USING NET PRESENT VALUE CRITERIA TO EVALUATE INVESTMENTS

UNIT LEARNING OUTCOME

At the end of the unit, you are expected to:

1. Mathematically express the Net Present Value (NPV)

2. Use Excel in determining NPV at the beginning, end, middle and irregular intervals.
3. Make a sound business decision based on the result of NPV

BIG PICTURE IN FOCUS

Let us start this module by asking several questions.

What is the Net Present Value (NPV)?

Does Excel have an NPV function?
How can I calculate the NPV of an investment if cash were received at the beginning of the year? How
about in the middle of the year?
If the cash flows were received in irregular intervals, how can I compute the NPV?

METALANGUAGE

In this section, the most important terms relevant to the study of NPV and to demonstrate ULO will be
operationally defined to establish a typical frame of reference as to how the text works in your chosen
business career. As you progress in this topic, there are terms you will encounter. Please refer to these
definitions in case you face difficulty in understanding strategic compensation concepts.

Net Present Value (NPV), the flow of cash the investment received at different periods in time,
measured in today’s peso

The NPV (rate, range of cells) is the Excel NPV syntax, which for the range of cells, determines the NPV
for the given rate of cash flow.

The XNPV function calculates the NPV of irregular cash flow.

ESSENTIAL KNOWLEDGE

Suppose there are two investments. Investment 1 entails a cash flow of P8,000 today and P14,000 in the
next two years. A year from now, the investment will earn P22,000. On the other side, Investment 2
entails a cash flow of P700. Initially, Investment 2 is better. However, the cash outflow for Investment 1
happened in the two years from now, while for Investment 2, cash outflow happened today. Between
the two investments, we want to determine which is better. Fortunately, by comparing at different
points in time the values of cash flows received, we can decide which investment is better.

The flow of cash the investment received at different periods in time, measured in today’s peso, is called
the net present value (NPV). Let us say that at present, you have P1 and decided to invest at a yearly
interest rate of r percent. In a year, the P1 will increase to pesos in the first year, pesos in
two years. We can claim that P1 today is equal to in n future years. It can be mathematically
expressed as

Dividing both sides of the equation by The result is

It demonstrates that the NPV of cash flow today can be multiplied by the cash flow received in n years

Let us say that the interest rate is 20% . We can calculate the NPV based on the two
investments:
Comparably, Investment 1 is comparably better than Investment 2, though the cash flow of Investment
2 is greater than investment 1. Nonetheless, Investment 1, since the negative cash flow comes later.

In computing investment 1 NPV, we need to copy Time 0 cash flow from C5 to C7. In determining the
NPV for investment 1 in years 1 and 2 the cash flow is calculated by D5/(1 + C3)^D$4 from D7 to E7. The
computed NPV of Investment 1 is in cell A5, which adds each year’s cash flow with the formula SUM(C7:
E7) in A5 and A6.

NPV in Excel at the End of the Year

The NPV (rate, range of cells) is the Excel NPV syntax, which for the range of cells, determines the NPV
for the given rate of cash flow. The Excel function calculations do not determine the NPV for Investment
1. Rather the formula NPV(r_, C5; E5)calculates the NPV of the following chain of cash flows: a year from
now (-P8,000); two years from now (P22,000), and three years from now (-14,000). It is called End of the
Year for Investment 1. The NPV is 509.26 for Investment 1.

NPV of Cash flow (Beginning and Middle of the Year)

Suppose that we want to determine the NPV of Investment 1 cash flow at the beginning of the year. It is
to use the function C7+NPV(r_,D5:E5) in cell C11. Notable the formula did not discount the cash flow at
Time 0, since it is in the ‘today’s” peso value. In cell, C11 reflects the correct Investment 1 NPV at
P611.11.

Let us say that the cash flow for an investment happened in the middle of each year. Naturally, in a
business that receives monthly income, we can estimate the 12 monthly payments received a lump sum
in the middle of the year. The NPV function is useful to compute the NPV sequence of cash flow at mid-
year.

Assuming the cash flow for Investment 1 happened mid-year, in cell C17 with SQRT(1 + 0.20)*C14
function to get a value of P557.87.
NPV with Irregular interval

Often cash flow does happen in irregular intervals, which creates greater difficulty in calculating the NPV
or the IRR. The Excel has the XNPV function to calculate the NPV of irregular cash flow. The
XNPV(rate,values,dates) syntax is the function. It is essential to list the earliest date, but succeeding
dates cannot necessarily be in chronological order.

In demonstrating the use of the XNPV function is shown in the figure below. Let us say that on June 8,
2019, you paid out P900 and in later dates receive the following amounts

 P300 on July 15, 2019

 P400 on January 11, 2020
 P200 on March 8, 2020
 P100 on July 25, 2020

What is NPV if the interest rate is 10 percent? In cells, D3 to D7 are the dates, and the cash flows in E3 to
E7. In the cell, D11 enters the function XNPV(A9,E3:E7,D3:D7) to determine the projected NPV on July
15, 2019, pesos because it is the first date identified. The project has an NPV, on July 15, 2019, of P58.52

Calculating the XNPV function is through the following steps:

1. In column F, calculate the number of years after June 8, 2019, that each date happened. For instance,
July 15, 2019, is years after June 8.

2. Years after the discount cash flow is

For instance, the July 15, 2019 cash flow is discounted by

3. The overall cash flows are sum up in cell E11 as (cash flow value) * (discount factor)
 LET’S CHECK

1. A PBA player was offered a P500,000 signing bonus and P1,000,000 for each year in 2021, 2022, and
2023. The current interest rate is 10 percent; without any taxes, is it better if he receives P3,000,000
now? What if the interest rate is 8 percent?

2. The director of Distance Home Décor submitted a project with the following cash flow:

Present 2021 2022 2023

-P5 million P3 million P4 million -P2 million

If the cost of capital is 15 percent, should Distance Home proceed with the project?
3. Starting a month from now, a client will pay Distance Home Décor P1,500 for the layaway plan for the
next three years. If the income for a year is received at the middle of a year, calculate the NPV of these
incomes if the interest rate is 15 percent.

4. Use the XNPV to calculate all income for the Distance Home Décor at the middle of the year. Please
refer to problem number 3.

LET’S ANALYZE

1. Suppose that throughout four-years cashflow reflected in the table below and at the rate of 0.15,
determine the NPV at the end of the year

Year 1 Year 2 Year 3 Year 4

-200 400 -700 1,000

Consider that the cash flow is at the beginning of each year.

2. After graduating from BSAIS, a student started working with a P300,000 annual pay on October 1,
2020. The firm promised him a 3 percent raise per year until retirement on October 1, 2059. If the cost
of capital is 5 percent a year, calculate the present value before taxes.

SELF-HELP

The articles below can help you acquire a better understanding of the uses of NPV in business decision-
making. The first article focuses on the time value of money as a critical factor in deciding on a project or
investment. The second article is a step-by-step Excel creation of financial modeling using the
spreadsheet.

Advantages and Disadvantages of NPV

https://www.wallstreetmojo.com/advantages-and-disadvantages-of-npv/

NPV Formula
https://corporatefinanceinstitute.com/resources/knowledge/valuation/npv-
formula/#:~:text=%3DNPV(discount%20rate%2C%20series%20of%20cash%20flow)&text=Example%20of
%20how%20to%20use,flow%20cells%20and%20%E2%80%9C)%E2%80%9D.
 IN A NUTSHELL

In this module, you have successfully studied the application of the NPV to evaluate a project or
investment. There were also everyday business situations such as determining NPV at the beginning,
middle, or end of the period, including irregular periods. Please enumerate at least three business
situations wherein NPV is challenging to apply.

1.

2.

3.