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Wize University Introduction to Finance Textbook > Capital Budgeting

Net Present Value

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Net Present Value

  • Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows.
  • NPV is used in capital budgeting to analyze the profitability of a projected investment or project.
  • A project with an NPV greater than zero is profitable, if the NPV is negative it is not profitable and should be rejected.

Financial Calculator

  • The financial calculator has a net present value feature that can replace the formula in most cases.
  • You must enter all the cash flows into the calculator along with the cost of capital, the calculator will do the rest.
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Example: Net Present Value (NPV)

You are considering 5-year investment that will require in initial cash outlay of $40,000. The expected inflows in years 1 through 3 are $10,000; then $12,000 in year 4 and $20,000 in year 5. Your cost of capital is 12% per year.

What is the net present value of the investment?

Practice: Net Present Value (NPV)

An investment requires an initial after-tax cash outlay of $6,000 and will return $3,000 in the first year, $3,000 in the second year and $4,000 in the third. If the investor's cost of capital if 9%, what is the net present value of this investment?
Round final answer to 2 decimal places
The net present value is$
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Example: Net Present Value

Calculate the net present value of an investment that requires an upfront outflow of $100,000 and will return $24,000 per year forever. The investor's cost of capital is 15%.

Practice: Net Present Value

An investment requires an initial after-tax cash outlay of $50,000. The investor will receive $8,000 per year indefinitely. At the end of the 5th year, the investor will be required to pay a one-time $10,000 maintenance fee.

What is the net present value of this investment if the investor's cost of capital is 12%.

Round your final answer to 2 decimal places
The net present value is$
Extra Practice
Question 2
A project requires an initial investment of $100,000 and will return $30,000 per year indefinitely. The firm's average cost of capital is 8% and this project is slightly riskier than their usual operations.
Risk premiums:
Question 1
A firm is considering a project with an initial after-tax cash outflow of $5,000 and inflows of $1,000 in year 1, $6,000 in year 2 and $3,000 in year 3. The firm's cost of capital is 6% .
Compute the net present value for this project.
ABC Company is considering a new project that will require an initial investment of $100,000. The project is expected to generate the following cash flows over the next five years:
Year 1: $30,000 Year 2: $40,000 Year 3: $50,000 Year 4: $40,000 Year 5: $30,000
The required rate of return for this project is 10%.