NPV Function (Table of contents)
NPV Function in Excel
The Microsoft Excel NPV function calculates the net present value of an investment.
The NPV function is a built-in function that is classified as a Financial Function. The NPV (Net Present Value) gives the actual value or present value of a future flow of funds. The present value of future cash flow shows the current worth of it. To calculate the current value, one must make use of a discount rate. The NPV doesn’t just includes only the positive cash flows or inflows but also all expenses, including the initial investment.
If the NPV is positive, it shows that the actual value of all incomes is greater than the actual value of all expenses and the investment is prudent because it adds much more value than the best alternatives.
The cash flows are discounted using a discount rate that corresponds to the best alternative investment.
NPV Formula in Excel
The Formula for the NPV function is as follows:
Rate (required) – It is the discount rate suitable for the investment which is used to discount the projected net cash flows to time 0.
Values (required) – Refers to the stream of cash flows that the project is generating. The stream of cash flows must be compatible and equidistant i.e. the time should be equal between two cash flows.
The math behind the NPV Formula
Below is the mathematical formula for calculating an individual cash flow for the present value.
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NPV = F / [ (1 + i)^n ]
Where,
PV – Present Value
F – Future payment (cash flow)
i – Discount rate (or interest rate)
n – the number of periods in the future the cash flow is
Use of NPV Formula in Excel
Most financial analysts don’t calculate the net present value with a calculator, instead, they use NPV function.
=NPV(discount rate%, series of cash flow)
Step 1 – Enter the discount rate in a cell.
Step 2 – Enter the cash flows in the series (In consecutive cells).
Step 3 – Type “=NPV (“ select the discount rate “,” select the cash flow cells “)”.
The NPV function returns the result as $34.4.
Issues with NPV
First of all, what’s the issue with NPV in Excel? Why so many people face issues while using it? Well, contradictory to popular belief, NPV function does not actually compute the Net Present Value. Instead, it computes the present value of a series of cash flows but it doesn’t net out the actual cash outflow at zero time period. This actual outflow of the cash actually needs to be subtracted out manually when using the NPV function.
Before we get into an example, let’s get some concept and understand what NPV actually means in finance. NPV is directly the difference between value and cost. Which implies, to find NPV we just take the present value of a series of future cash flows at a specific discount rate, then simply subtract out what our original cost is to obtain that stream of cash flows.
How to Use NPV Function in Excel?
This NPV function is very simple easy to use. Let us now see how to use the NPV Function with the help of some examples.
Let’s take a few examples. Suppose we have the following series of cash flows as shown in the below examples:
Example #1
Suppose we are working on the below dataset on cash inflows and outflows:
The below spreadsheet gives a simple illustration of how NPV function works in Excel.
The rate arguments that is applied to the function is stored in cell C11 and the value arguments have been stored in cells C5-C9 of the spreadsheet.
The NPV is entered in the cell C12.
The NPV Formula is applied in cell C12.
When we apply the NPV function on a dataset in the spreadsheet, it gives the result as $1128.45.
Note that, in this example, the investment made initially of $200 (shown in cell C5), took place at the end of the first period. That is the reason why this value is considered as the first argument (i.e. value1) to the NPV Function.
The above NPV calculation of $1128.45 considers the -$200.00 initial cash outlay in the series of cash flows. The formula used in cell C12 to calculate NPV is:
=NPV(C11,C5:C9)
Example #2
The below spreadsheet shows another illustration in where the first payment is made initially during the start of the first instance and why this payment should be taken into consideration in the NPV Function.
The rate is again 10% and is in cell C11 and value arguments like the cash flow of the transactions are in between the cells ranging C5-C9 of the spreadsheet. The NPV function is entered in cell C12.
This time, when we apply the NPV function on the dataset in the spreadsheet, it gives the result as $1241.29.
We notice that the investment made initially of $200 (shown in cell C5), was done during the investment at the start of the first instance, this value gets excluded in the arguments of the NPV Function. Instead, the first cash flow is added separately to the NPV result.
The above NPV calculation of $1241.29 correctly excludes the $200 initially invested cash outlay in the series of cash flows and then nets it out from the result of the NPV Formula. Below is the formula used in cell C12 to correctly calculate NPV above:
=NPV(C11,C6:C9)+C5
As described in the above example, the NPV (Net Present Value) formula in excel is based on cash flows in the future. If the first cash flow takes place at the initial stage of the first instance, the first cash flow value should be excluded from the values arguments and must be added to the NPV result separately.
Things to Know about the NPV Function?
- The NPV investment begins one period ahead of the date of the value1 cash flow and ends with the last cash flow in the list. The NPV computation on excel is derived upon by the future cash flows. If the first cash flow is made at the starting of the first period, the first value must be directly added to the NPV result, eliminated in the values arguments. Check the examples below for more information.
Let’s take n as the number of cash flows in the list of values, the formula for NPV (Net Present Value) in Excel would be calculated using:
- If the arguments are provided in a range and all of the non-numeric values in the range are ignored.
- If the arguments are provided individually, numbers, logical values, blank cells and text representation of numbers are computed as numeric values, while other values of a cell which are in text and error form are ignored by the function.
- The key difference between PV functions and NPV function is that PV function allows the flow of cash to begin either at the start or at the end of the period.
- We need to type in transactions, payments and income values in a correct sequence as NPV functions use the order of the 2nd argument i.e. value1, value2, value3 … to check the order of cash flows.
- NVP (Net Present Value) function in the latest versions of Excel can accept up to 254 value arguments, but with Excel 2003, only up to 29 values can be supplied to the function.
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This has been a guide to NPV Function. Here we discuss the NPV Formula and how to use NPV along with practical examples and downloadable excel templates-
