Time Value of Money
1. Net Present Value (NPV)
- is found by subtracting the initial investment from the present value of the cash inflow discounted at a rate equal to the firms cost of capital.
NPV – present value of cash inflows – initial investment
e.g. The calculation of NPV’s for benefit company's capital expenditure alternatives
Use Table A-4 Project A
Annual cash inflow $14,000
X present value annuity interest factor, PVIF 3.791
present value of cash inflow $53,000
- initial investment 42,000
Net present value (NPV) $11,074
Use table A-3 Project B
Cash inflow Present-value interest factor (PVIF) Present value
(1)X(2)
Year (1) (2) (3)
1 $28,000 .909 $25,452
2 12,000 .826 9,912
3 10,000 .751 7,510
4 10,000 .683 6,830
5 10,000 .621 6,210
Present value of cash inflow $55,914
45,000
$10,914
- Initial investment
Net Present Value (NPV)
Decision Criteria
If NPV is greater than $ 0, accept the project if NPV
Is less than $0 , reject the project.
EXERCISE
Dane cosmetics is evaluating a new program-mixing machine. The asset requires an initial investment of $24,000 and will generate after tax cash inflow of $5,000 per year for eight years. For each of the required rate of return listed:
Calculate the net present value
indicate whether to accept or reject the machine
explain your decision
1. the cost of capital is 10 percent
2. the cost of the capital is 12 percent
3. the cost of capital is 14 percent
Use table A-4