AM C

NPV (Net Present Value)

Basics
AM C

DESCION CHOICE ON AN INVESTMENT

Situation 1:
An insurance agent promises to pay
back a sum of Rs 1,00, 000 after 10 years
for an investment amount of
Rs 10, 000
Situation 2:
A Person promises to return Rs 12, 000 in
a month’s time for Rs 10, 000/- which he
takes as a loan. What would we decide?
Would we immediately draw out a cheque for the
insurance agent or hand over Rs 10, 000 to
Person as a loan?
AM C

 Likewise, All Companies & Financial

Institutions, Investors invest in
tangible assets like factories,
machinery, Offices, Shares, Bonds,
Debentures etc. & also in intangible
assets like patents or trademarks etc
With an expectation of receiving
more assets or making more money
by effectively utilizing these assets.
AM C

More Money Returns (ROI)

=
Safe Future + Survival
AM C

But what would happen if the

value of money receive after say 2
years or 5 years is less than the
Present Value of money?
(Like drop in Shares or in NPA –
Non performing Assets, Inflation)
AM C

03 Steps Process
A) First Step: Understanding the relationship
between the value of money today and that
of money in the future.

B) Second Step: Looking at how funds invested

at a specific interest rate will grow over time.

C) Third Step : We then ask how much would

need to invest today to produce a specified
future sum of money.
AM C

PRESENT VALUE
A) Money can be invested to earn interest. If we
are offered the choice between Rs100, 000
now and Rs100, 000 at the end of the year,
we naturally take the money now to get a
year’s interest.
B) Financial managers make the same point
when they say that money in hand today has
a time value or when they quote perhaps the
most basic financial principle:
C) (Rupee today is worth more than a Rupee tomorrow.)
AM C

INVESTMENT VALUE CALCULATIONS

A) Rs 100 invested for 1 year at 6%

will grow to a future value of
100 X1.06 = Rs 106.
B) How much to invest now in order
to get Rs 106 at the year?

Financial managers refer to this as the

present value (PV) of the Rs 106 payoff.
AM C

Step 1 Future & Present Value

1.. Future value is calculated by
multiplying present investment by
1 plus the interest rate,.06, or 1.06.

2.. To calculate present value, we

simply reverse the process and
divide the future value by 1.06:
AM C

PRESENT VALUE Vs FUTURE VALUE

Future value
Present Value = PV = ------------------- =
1.06

Rs.106
Present Value = PV =------------------- = Rs100
1.06
AM C

PRESENT VALUE Vs FUTURE VALUE

A) What is the present value

of, say, Rs112.36 to be
received 2 years from now?
B) “How much would we need
to invest now?”
Rs100 × (1.06)² = 112.36
AM C

PRESENT VALUE Vs FUTURE VALUE

However, if we don’t know, or forgot

the answer, we just divide future
value by (1.06)² to get to the answer:

Rs 112.36
Present Value = PV = --------------- = 100
(1.06)²
AM C

PRESENT VALUE Vs FUTURE VALUE

In general, for a future value or payment
t periods away, present value is
Future value after t periods
Present Value = ---------------------------------
(1+ r) t
a) The interest rate r is known as the discount rate
b) Present value is often called the discounted
value of the future payment.
To calculate present value, we discounted the
future value at the interest r.
AM C

Propositions
What happens if the interest rate
is more than the inflation rate?

What happens if the interest rate

is less than the inflation rate?

What happens if the interest rate

is equal to the inflation rate?
AM C

Another basic financial principle:

A) A risky rupee is worth less than a

safe one.
B) Most investors avoid risk when they
can do so without sacrificing return
AM C

An investment of Re 1 earning
an interest rate of r will increase
in value each period by the
factor (1+r).
After t periods its value will
grow to (1+r) t.
This is the future value of the Re 1
investment with compound
interest.
AM C

The present value of a future cash

payment is the amount that you would
need to invest today to match the
future payment.

To calculate present value we divide

the cash payment by (1+r) t.

The discount factor measures value

today of Re 1 received in period t.
AM C

The present value of an investment is a

measure of how much it is worth.

The difference between the present

value of an investment and the required
investment is known as the Net present
value.

Net present value measures how much

better off you would be by undertaking
the investment.