Present Value vs Net Present Value

Difference Between Present Value vs Net Present Value

Present Value

Present Value is basically the discounted value of future cash flow at a specific discounting rate. If the future cash flows are spread over multiple years than present value is some of the discounted value of future cash flows.

Formula for calculation of Present value:

Present Value (PV)= (FV1 / (1+r)) +(FV2/(1+r) ^2)   + (FV3/(1+r) ^3) +———+ (FVn/(1+r) ^n)

Wherein FV is cash flow in future years and r is the discounting rate.

N= represents the year of the cash flow

Demonstration for Calculation of Present Value

Present Value of USD 100 in two years’ timeline with a discount rate of 8% is as below:

• Present Value (PV) = Future Value (FV)/ (1+r) ^n
• Present Value = 100/ (1+8%)^2
• Present Value = 100/1.1664
• Present Value = USD 85.73

So the present value of USD 100 which is expected to be received after 2 years at present is USD 85.73. Therefore, a present value of future cash flow is always less than the actual cash flow in that specific year because of the concept of the time value of money.

Present Value is very useful in real-world applications in estimating the present value of future requirements such as house EMI for a house loan, education loan for children. Present Value concept is widely used in bonds pricing and valuation in Corporate Finance.

Net Present Value

Net present value is very similar to the present value except for the consideration of capital investments made in the initial year while calculating net present value. Therefore, Net Present Value is the sum of a discounted value of future cash flows less initial investments.

Formula for calculation of Net Present value:

Net Present Value (PV)= (FV1 / (1+r)) +(FV2/(1+r) ^2) + —–+ (FVn/(1+r) ^n)- (Initial Investments)

Wherein FV is cash flow in future years and r is the discounting rate.

N= represents the year of the cash flow

Demonstration for Calculation of Net Present Value

 A Company XYZ Corporation makes an investment of USD 100 million in a Project. The estimated cash flows from the project in the next 5 years for the company are as below:

 Let’s calculate the NPV of the investment for the Project at a discount rate of 8%.

• Net Present Value= Present Value of Future Cash Flows- Initial Investment
• Net Present Value = 20/ (1+8%)+ 25/ (1+8%)^2 + 30/ (1+8%)^3 +35/ (1+8%)^4+40/ (1+8%)^5-100
• Net Present Value = 116.72-100
• Net Present Value = 16.72

Net Present Value = USD 16.72 million

Applications

The concept of NPV is widely used in capital budgeting, making investment decisions, selection between multiple projects for investment considerations, comparing two investments etc. by finance professionals and investment bankers.

Head To Head Comparison Between Present Value vs Net Present Value (Infographics)

Below is the top 7 difference between Present Value vs Net Present Value

Key Differences Between Present Value vs Net Present Value

Both Present Values vs Net Present Value are popular choices in the market; let us discuss some of the major Difference Between Present Value vs Net Present Value

• Present Value is basically the sum of the discounted value of future cash flow. However, Net present value is the sum of a discounted value of future cash flows less initial investments.
• Net Present Value takes into account the initial investment and future cash flows to calculate the incremental value addition. However, Present Value only takes into account the discounting of future cash flows.
• Present value basically provides an absolute value which is the discounted value of future cash flows. However, Net Present value measures incremental value created due to an investment decision such as net value addition to a Company due to investment in a specific project.
• Net present value finds much more relevance for Companies and is relatively complex to use than Present Value. Present value is used by individuals in day to day decision making and it is relatively easier to use.
• Net Present Value helps in discounting the different amount of future cash flows at different time periods with incoming as well as outgoing cash flows and therefore it is relatively complex but much more helpful in decision making than present value.
• Brief understanding of the concept of Present value is required to understand and calculate the Net present value and both are related to the concept of the time value of money.
• Present value concept is useful in decision making by individuals in calculating bond prices for investments, loan pricing calculation for various requirements, estimating the present investment value of future requirements etc. However, the Net Present Value concept is mostly used by Companies in making investment decisions, comparing the attractiveness of multiple projects, capital budgeting decisions etc.

Present Value vs Net Present Value Comparison Table

Below is the 7 topmost comparison between Present Value vs Net Present Value

Conclusion – Present Value vs Net Present Value

Both Present Value vs Net Present Value, are tools to make investment decisions, future planning, purchases, borrowings etc. for Companies as well as individuals. Net Present Value provides more effective information in decision making for Companies in comparison to Present Value which is more effective and helpful for individuals in decision making.

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