NET PRESENT value

[ EMT 253/development appraisal ]

MOHD FARID BIN SA’AD
ESTATE MANAGEMENT DEPARTMENT
FSPU,UiTM PERAK

1
-NPV is the short form for net present value.

-Net present value is a calculation that compares the

amount invested today to the present value of the
future cash takings from the investment.

-In other words, the amount invested is compared to

the future cash amounts after they are discounted by a
specified rate of return.

2
The principle of NPV

means THE PROJECT IS FEASIBLE

means THE PROJECT IS NOT FEASIBLE

means NO FINANCIAL ENHANCEMENT

3
 Example : Investment A n
PV = 1/ (1+i)
1
Year Income PV@ D/C Sum
= 1/ (1+0.1)
10% = 0.9091
1 60,000 0.9091 54,545
2 40,000 0.8264 33,058
3 20,000 0.7513 15,026
4 40,000 0.6830 27,321
5 40,000 0.6209 24,837
Total 154,787 NPV
Less 140,000 = 154,787 – 140,000
Outlay
= 14,787
NPV 14,787

4
 Example : Investment B n
PV = 1/ (1+i)
1
Year Income PV@ D/C Sum
= 1/ (1+0.1)
10% = 0.9091
1 20,000 0.9091 18,182
2 40,000 0.8264 33,058
3 40,000 0.7513 30,053
4 60,000 0.6830 40,981
5 60,000 0.6209 37,255
Total 159,528
NPV
Less 140,000
Outlay = 159,528 – 140,000
NPV 19,528 = 19,528

5
 Analysis
Investment A INVESTMENT B
NPV NPV
14,787 VS 19,528

NPV ( + ) means THE PROJECT IS FEASIBLE

NPV ( - ) means THE PROJECT IS NOT FEASIBLE

NPV ( 0 ) means NO FINANCIAL ENHANCEMENT BUT AN

EXPANSION OF ACTIVITIES

6
Question..

7
 Year Cash Flow
Project A Project B
0 RM250,000 RM30,000
1 RM50,000 RM20,000
2 RM40,000 RM15,000
3 RM80,000 RM10,000
4 RM100,000 RM40,000
5 RM25,000 RM10,000

If you use the Net Present Value method, which

project will be selected at 10% as the rate of
return? Give your reasons on this?
8
ANSWER…

9
Year
Project PV@ CUM.FLOW Project PV@ CUM.FLOW
A 10% B 10%

0 - RM250,000 1.000 - 250,000 RM30,000 1.000 - 30,000

1 RM50,000 0.909 45,450 RM20,000 0.909 18,180
2 RM40,000 0.826 33,040 RM15,000 0.826 12,390
3 RM80,000 0.752 60,160 RM10,000 0.752 7,520
4 RM100,000 0.6830 68,300 RM40,000 0.6830 27,320

5 RM25,000 0.6209 15,522 RM10,000 0.6209 6,209

NPV -27,528 NPV 41,619

10
Project A Project B

= -27,528 = 41,619
X 100 X 100
250,000 30,000

= -11.01% = 138.73 %

11
 PROFITABILITY index
[ EMT 253/development appraisal ]
MOHD FARID BIN SA’AD
ESTATE MANAGEMENT DEPARTMENT
FSPU,UiTM PERAK

12
 INTRODUCTION
- An index used to evaluate proposals for which net present values
have been determined.

- The profitability index is determined by dividing the present value of

future cash flows by value of initial capital invested

13
The principle of PI

ACCEPT THE PROJECT

REJECT THE PROJECT

14
 Example : Investment A
Year 1 2 3 4 5 Total Initial NPV
investment

Income 60,000 40,000 20,000 40,000 40,000

PV@10% 0.9091 0.8264 0.7513 0.6830 0.6209

D/C Sum 54,545 33,058 15,026 27,321 24,837 154,787 140,000 14,787

P I : = 154,787 / 140,000
= 1.105

15
 Example : Investment B
Year Income PV@ D/C Sum
10%
1 20,000 0.9091 18,182
2 40,000 0.8264 33,058
3 40,000 0.7513 30,053
4 60,000 0.6830 40,981
5 60,000 0.6209 37,255
Total 159,528
Initial 140,000
investment
NPV 19,528

PI: = 159,528 / 140,000

= 1.139
16
 Analysis
Investment A INVESTMENT B
PI VS PI
1.105 1.139

PI>1 means ACCEPT THE PROJECT

PI<1 means THE PROJECT IS REJECTED

17
QUESTION..

18
 Year Cash Flow
Project A Project B
0 RM250,000 RM30,000
1 RM50,000 RM20,000
2 RM40,000 RM15,000
3 RM80,000 RM10,000
4 RM100,000 RM40,000
5 RM25,000 RM10,000

If you use the P I method, which project will be selected at 10%

as the rate of return? Give your reasons on this?

19
ANSWER…

20
 Project PV@ CUM.FLOW Project PV@ CUM.FLOW
Year
A 10% B 10%

1 RM50,000 0.909 45,450 RM20,000 0.909 18,180

2 RM40,000 0.826 33,040 RM15,000 0.826 12,390
3 RM80,000 0.752 60,160 RM10,000 0.752 7,520
4 RM100,000 0.683 68,301 RM40,000 0.683 27,320
5 RM25,000 0.620 15,523 RM10,000 0.620 6,200
TOTAL 222,474 TOTAL 71,610
INITIAL INVESTMENT 250,000 INITIAL INVESTMENT 30,000

PI 0.89 PI 2.387

21
AVERAGE rate of return
[ EMT 253/development appraisal ]
MOHD FARID BIN SA’AD
ESTATE MANAGEMENT DEPARTMENT
FSPU,UiTM PERAK

22
Method of investment appraisal which determines return
on investment by totaling the cash flows (over the years for
which the money was invested) and dividing that amount
by the number of years.

Formula for average rate of return?

Average rate of return=

Average profit / Initial investment * 100%

23
 Year Cash Flow
Project A Project B
0 (RM100,000) (RM100,000)
1 RM75,000 RM50,000
2 RM50,000 RM35,000
3 RM45,000
4 RM50,000

Q; Calculate The Average Rate of Return for each project

and which project will be selected

24
 Year Cash Flow
Project A Project B
0 ($100,000) ($100,000)
1 $75,000 $50,000
2 $50,000 $35,000
3 $45,000
4 $50,000
Total Income $ 125,000 $ 180,000
Average income $ 62,500 $ 45,000

Total Income: ARR 62% 45%

$75,000+$50,000
= $125,000

Average Income :
$125,000 / 2 The best project to be chosen
= $62,500

ARR :
$62,500 / $100,000 * 100
= 62%

25
 Exercise 1
Year Project A Project B Project C
(RM) (RM) (RM)
0 (100,000) (100,000) (100,000)
1 50,000 75,000
2 35,000 40,000
3 45,000 (5,000)
4 50,000 50,000 200,000

Calculate The Average Rate of Return for each project.

26
 Answer
Year Project A Project B Project C
0 RM100,000 RM100,000 RM100,000
1 RM50,000 RM75,000
2 RM35,000 RM40,000
3 RM45,000 (RM5,000)
4 RM50,000 RM75,000 RM200,000

Total income RM180,000 RM185,000 RM200,000

Average
income RM45,000 RM46,250 RM50,000
AVR 45% 46% 50%
The best project to be chosen

27
 Exercise 2
You have been appointed by your client to
consider these 2 mutually exclusive projects
which require an initial outlay of RM50,000.
Below are the cash flows expected from each
project:
. Project A (RM) Project B (RM)
Year 1 10,000 -15,000
Year 2 -15,000 20,000
Year 3 30,000 35,000
Year 4 35,000 25,000
Year 5 25,000 10,000

28
 Answer
Year Project A Project B
1 10,000 -15,000
2 -15,000 20,000
3 30,000 35,000
4 35,000 25,000
5 25,000 10,000

Total income 85,000 75,000

Average
income 17,000 15,000
AVR 34% 30%

The best project to be chosen

29
INTERNAL RATE OF return
[ EMT 253/development appraisal ]
MOHD FARID BIN SA’AD
ESTATE MANAGEMENT DEPARTMENT
FSPU,UiTM PERAK

30
The Internal Rate of Return (IRR) is defined
as the discount rate that makes the project
have a zero Net Present Value (NPV).

31
 FORMULA IRR
R = lower discount rate
R = higher discount rate

R1 + (R2 – R1) X NPV R1

NPV R1 + NPV R2

NPV R = NPV lower discount rate

NPV R = NPV higher discount rate

 Case 1

10 %

Year 1 2 3 Less NPV

outlay
Inflow 1,024 4,000 3,000
PV@10% 0.9091 0.8264 0.7513
D/C SUM 931 3306 2254 6,000 491
 Year 1 2 3 Less NPV
outlay
Inflow 1,024 4,000 3,000
10 % PV@10% 0.9091 0.8264 0.7513
D/C SUM 931 3306 2254 6,000 491

Year 1 2 3 Less NPV

outlay
16 % Inflow 1,024 4,000 3,000
PV@16% 0.8621 0.7432 0.6407

D/C SUM 883 2973 1922 6,000 -223

- The IRR must between 10% and 16%

- Can Determined by using Following Formula
 R1 + (R2 – R1) X NPV R1
NPV R1 + NPV R2

= 10 + (16 – 10 ) X 491
491 + 223

= 10 + ( 6 X 0.06876 )
= 10 + 4.12
= 14.12 %

- The IRR must between 10% and 16%

 Case 2
8%
Year 0 1 2 3 4 5 Total

Inflow 0 5,000 15,000 30,000 40,000 50,000 140,000

PV@8% 4,629 12,860 23,828 29,411 34,036 104,764
Outflow 50,000 50,000 100,000
PV@8% 50,000 46,296 96,296

NPV = 104,764 – 96,296 = 8,468

 12%
Year 0 1 2 3 4 5 Total

Inflow 0 5,000 15,000 30,000 40,000 50,000 140,000

PV@12% 4,464 12,000 21,428 25,477 28,376 91,745
Outflow 50,000 50,000 100,000
PV@12% 50,000 44,642 94,642

NPV = 91,745 – 94,642 = - 2,897

Graf Linear : x
=
4-x
2,897 8,468

10,803x = 12,300
8,468

x = 1.13

IRR = 12 – 1.13
= 10.87
4-x x

8% 12%
- 2,897