Net present value - calculation of investments

Many investors had to lose sleep and appetite in trying to determine the most effective way to minimize investment risks and maximize the profits. However, it is only necessary to increase economic literacy. Net present value will allow to look at financial issues much more objectively. But what is it?

Cash

Before talking about such a question as the net present value, it is first necessary to deal with the related concepts. Positive incomes (cash flows) are the means that enter the business (received interest, sales, proceeds from stocks, bonds, futures and so on). Negative flow (that is, costs) is a means that flow from the company's budget (wages, purchases, taxes). Net present value (absolute net financial flow), in fact, is the difference between negative and positive flows. It is this value that answers the most important and most exciting question of any business: "How much money does the cashier have?" To ensure dynamic business development, the right decisions are needed regarding the direction of long-term investments.

Questions about investments

Net present value is directly related not only to mathematical calculations, but also to the attitude to investment. Moreover, understanding this issue is not so simple as it seems, and relies primarily on the psychological factor. Before investing money in any project, you need to ask yourself a preliminary number of questions:

- Will the new project be profitable and when?

- Maybe it's worth investing in another project?

The net present value of investments should be considered in the context of other issues, for example negative and positive flows of the project and their impact on initial investment.

Movement of assets

The financial flow is a continuous process. Assets of the enterprise are treated as the use of funds, and capital and liabilities are treated as sources. The final product in this case is a set of fixed assets, labor, raw material costs, which are ultimately paid for in cash. Net present value considers the movement of financial flows.

What is an NPV?

Many people who are interested in economics, finance, investment and business, met this abbreviation. What does it mean? NPV stands for NET PRESENT VALUE, and translates as "net present value." This is calculated by summing up the incomes that the enterprise will bring during the operation, and the cost of the project. Then the amount of income is deducted from the amount of expenses. If, as a result of all calculations, the value is positive, then the project is considered as profitable. It can be concluded that the net present value is an indicator of whether the project will generate revenue or not. All future incomes and expenses are discounted at the appropriate interest rates.

Features of computing the net present value

Net present value is a definition of whether the cost of a project is greater than the costs spent on it. This value indicator is estimated with the calculation of the price of cash flows generated by the project. It is necessary to take into account the requirements of investors and the fact that these flows can become objects of trading on stock exchanges of securities.

Discounting

The net present value is calculated taking into account the discounting of cash flows at rates equal to the alternative costs of investing. That is, the expected rate of return on securities is equated with the same risk as the project in question. In developed stock markets, assets that are absolutely identical in terms of risk level are estimated in such a way that they form the same rate of return. The price at which investors participating in the financing of this project expect to receive a rate of return on their investments is obtained precisely by discounting the flow of funds at a rate equal to the alternative costs.

Net present value of the project and its properties

There are several important properties of this method of project evaluation. The net present value allows to estimate investments taking into account the general criterion of maximization of cost which is available to investors and shareholders. This criterion is subject to financial and foreign exchange operations both in attracting funds and capitals, and in their placement. This method focuses on cash income, which is reflected in the proceeds to the bank account, while neglecting the accounting income that is reflected in the accounting records. It should also be remembered that the net present value uses the alternative cost of funds for investment. Another important property is the subordination to the principles of additivity. This means that it is possible to consider all projects both in the amount and individually, and the sum of all components will be equal to the cost of the overall project.

Fair value indicator

The net present value depends on the value of the current (PV) value. This term is understood as the value of the proceeds of funds in the future, which relates to the present moment by discounting. The calculation of net present value usually includes the calculation of the present value. Find this value can be a simple formula that describes the following financial transaction: placement of funds, pay, recurrence and one-time repayment:

PV = FV / (1 + r).

Where r is the interest rate, which is a payment for money borrowed;

PV - is the amount of funds that are intended for placement on terms of pay, urgency, repayment;

FV is the amount necessary to repay a loan, which includes the initial amount of debt, as well as interest.

Calculation of net present value

From the current price indicator, you can go to the calculation of NPV. As mentioned above, the net present value is the difference between discounted future cash inflows and total investment (C).

NPV = FV * 1 / (1 + r) -C

Where FV is the sum of all future project revenues;

R - indicator of profitability;

C is the total amount of all investments.