 # What is Net Present Value: Concept, Usage & Examples

## Pros and Cons of the NPV

 Pros Cons The time value of money is taken into consideration Dependent on inputs, estimates and long-term projections Inclusion of discounted cash flow using the company's capital cost This does not consider project size Easy to interpret as it returns a single dollar value As quantitative inputs drive it, there is no consideration for nonfinancial metrics Easier to calculate by using calculators and spreadsheets Difficult to calculate manually

## Project 1

In this project, we will take into account a four-year time plan.

 Initial investment \$10,000 Discoun trate 10% Year 1 \$5,000 Year 2 \$15,000 Year 3 \$9,000 Year 4 \$18,000

Calculating the present value for each project year.

 Year 1 5,000/(1 + .10)^1 = \$4,545 Year 2 15,000/(1 + .10)^2 = \$12,397 Year 3 9,000/(1 + .10)^3 = \$6,762 Year 4 18,000/(1 + .10)^4 = \$12,294

Now to find the net present value for this project, we need to find the summation of these values and subtract the initial investment cost.

NPV = (\$4,545 + \$12,397 + \$6,762 + \$12,294) - \$10,000

Therefore, NPV = \$25,998

## Project 2

In this project, let us consider a two-year plan.

 Initial investment \$5,000 Discount rate 10% Year 1 \$8,000 Year 2 \$16,000

Calculating the present value for each project year.

 Year 1 8,000/(1 + .10)^1 = \$7,273 Year 2 16,000/(1 + .10)^2 = \$13,223

So, the resulting formula after calculating the present value for each cash flow and time:

NPV = (\$7,273 + \$13,223) - \$5,000

Therefore, NPV = \$15,496

As we compare the net present value of both these projects, the former is \$25,998 while the latter is \$15,496. Therefore, according to this result, the company should invest in Project 1 as it has a higher value.