Net Present Value

For new project managers

Net present value can be tricky to
learn, but it’s really very simple.
In this presentation I try to deliver
an explanation of what it is
And how to use it.
Your feedback to this slide pack
would be appreciated
Let’s get on with it…
What is Net Present Value?
What is Net Present Value?
What is Net Present Value?

Net
Present
Value
Net present value (NPV)
is a standard method for
the financial appraisal of
long-term projects.

Net
Present
Value
Present value of net
cash flows

Net
Present
Value
 What is it?

Cash flow is discounted

back to its present value
(PV).

Net
Present
Value
 Revenues – Costs = ?

2008 2009 2010 2011 2012

In today’s
terms

In today’s
terms

In today’s
terms

In today’s
terms
Simple, right?
 What is it?

But
what is
it?
1.Each cash inflow/outflow is
discounted back to its
present value (PV).

2.Then they are summed.

 Revenues – Costs = ?

2008 2009 2010 2011 2012

In today’s
terms

In today’s
terms

In today’s
terms

In today’s
terms
1.Each cash inflow/outflow is
discounted back to its
present value (PV).
1.Each cash inflow/outflow is
discounted back to its
present value (PV).

2.Then they are summed.

1.Each cash inflow/outflow
is discounted back to its
present value (PV).

2.Then they are summed.

1.Each cash inflow/outflow is
discounted back to its
present value (PV).

2.Then they are summed.

1.Each cash inflow/outflow
is discounted back to its
present value (PV).

2.Then they are summed.

1.Each cash inflow/outflow
is discounted back to its
present value (PV).

2.Then they are summed.

 Revenues – Costs = ?

2008 2009 2010 2011 2012

In today’s
terms

In today’s
terms

In today’s
terms

In today’s
terms
Got it yet?
1.Each cash inflow/outflow is
discounted back to its
present value (PV).

Year 1’s value in today’s terms,

Year 2’s value in today’s terms,
Year 3’s value in today’s terms,
Year 4’s value in today’s terms,
etc
2. Then they are summed.

Year 1+
Year 2+
Year 3+
Year 4+
Etc
------------
= Sum
 But what is the
formula all about?
t - the time of the cash flow

N - the total time of the project

r - the discount rate (the rate of return

that could be earned on an investment
in the financial markets with similar
risk.)

Ct - the net cash flow (the amount of

cash) at time t
(for educational purposes, C0 is commonly
placed to the left of the sum to emphasize
its role as the initial investment.)
 What is it?
t

the time of the cash flow

 What is it?

the total time of the project

 What is it?

the discount rate (the rate of return

that could be earned on an investment
in the financial markets with similar
risk.)
 What is it?

Ct

the net cash flow (the amount of cash)

at time t
(for educational purposes, C0 is commonly
placed to the left of the sum to emphasize
its role as the initial investment.)
The value of money over time
 The discount rate
10%

Y1 Y2 Y3 Y4
91% 83% 75% 68%
 The discount rate
10%

Y1 Y2 Y3 Y4
91% 83% 75% 68%

Why not…
Y1 Y2 Y3 Y4
91% 83% 75% 68%
 The discount rate
Because your 10% discount rate is worked
out backwards.

Last year was 10% greater than this year…

Why not…
Y1 Y2 Y3 Y4
91% 83% 75% 68%
 The discount rate
10%

Y1 Y2 Y3 Y4
91% 83% 75% 68%

So it looks like this

Excel can help
 NPV in excel

Help menu
“NPV”
 But it ain’t perfect
NPV investment
The
begins one period
before the date of
the value1 cash flow
and ends with the last cash flow in
the list. The NPV calculation is
based on future cash flows. If your
first cash flow occurs at the
beginning of the first period, the
first value must be added to the
NPV result, not included in the
values arguments. For more
information, see the examples
below
 The calculations in excel are …
NPV investment
The
different
begins one period
before the date of
the value1 cash flow
and ends with the last cash flow in
the list. The NPV calculation is
based on future cash flows. If your
first cash flow occurs at the
beginning of the first period, the
first value must be added to the
NPV result, not included in the
values arguments. For more
information, see the examples
below
 NPV in excel
NPV investment
The
begins one period
before the date of
the value1 cash flow
and ends with the last cash flow in
the list. The NPV calculation is
based on future cash flows. If your
first cash flow occurs at the
beginning of the first period, the
first value must be added to the
NPV result, not included in the
values arguments. For more
information, see the examples
below
NPV in excel


 NPV in worksheets
Financial
FinancialAnalysis
Analysis
for e-Learning Project 2006
for e-Learning Project 2006

Discount rate
Discount rate

YEARS: 1 2 3 4 Total
YEARS: 1 2 3 4 Total

Costs
Costs
Discount factor 0.91 0.83 0.75 0.68
Discount factor 0.91 0.83 0.75 0.68
Discounted costs
Discounted costs

Benefits
Benefits
Discount factor 0.91 0.83 0.75 0.68
Discount factor 0.91 0.83 0.75 0.68
Discounted benefits
Discounted benefits

Discounted benefits - costs NPV

Discounted benefits - costs NPV
Cumulative benefits - costs
Cumulative benefits - costs

ROI
ROI
Payback In Year:
Payback In Year:
 When is it used?

1. Assessing the value of a project

NPV is typically used for 2 reasons

2. Choosing which projects get priority

When is NPV used?
 1. Assessing the value of a project

NPV is typically used for 2 reasons

2. Choosing which projects get priority

 1. Assessing the value of a project

NPV is typically used for 2 reasons

2. Choosing which projects get priority

 1. Assessing the value of a project

NPV is typically used for 2 reasons

2. Choosing which projects get priority

 When do you use it?
Project 1 Project 2

Compare & Contrast

Which one is best?

Costs & Benefits

Is it worth our investment?

 Which is the better investment?

http://www.flickr.com/photos/makz/56920649/ http://www.flickr.com/photos/f2g2/75152105/
 Which was the better investment?

http://www.flickr.com/photos/orangebrompton/1858900270 http://www.flickr.com/photos/orangebrompton/1858900270
/ /
Questions
What is the discount rate?

What is IRR?
 Internal
Internal Rate
Rate
of
of Return
Return

What is IRR?
 The
The amount
amount you
you need
need
to
to earn
earn to
to make
make itit all
all
worthwhile
worthwhile

What is IRR?
 ItIt is
is based
based on
on things
things like
like
opportunity
opportunity cost,
cost, the
the
cost
cost ofof money
money and
and risk
risk

What is IRR?
 <0<

NPV < 0 NPV = 0 NPV > 0

The investment’s The investment’s The investment’s

return is less than return meets the return exceeds the
the discounted cash discounted cash discounted cash
threshold threshold threshold

<0 =0 >0
• What is NPV good for?
• When does a project manager use NPV?
• What project documents (or artefacts)
would you find NPV calculations in?
• How does NPV help in decision making?
• When is NPV not so useful?
• What impact does (would) NPV have on your
project?
 Answers
1. What is NPV good for? 1. Understanding the future value of
money in today’s terms
2. When does a project manager use 2. In presenting the cost-benefit
NPV? analysis, or justification for a
project
3. What project documents (or
artefacts) would you find NPV 3. Business cases, project plans, and
calculations in? project portfolio reports
4. How does NPV help in decision
making? 4. It helps compare the value of
5. When is NPV not so useful? different projects against
investment targets
5. If a project and it’s benefits are only
going to run for a short period (e.g.
less than a year) or if a project’s
6. What impact does (would) NPV have benefits are non financial
on your project? 6. Reflect on your project’s costs and
forecast benefits
 Another example
Financial Analysis
Financial Analysis
for e-Learning Project 2006
for e-Learning Project 2006

Discount rate 10%

Discount rate 10%

YEARS: 1 2 3 4 Total
YEARS: 1 2 3 4 Total

Costs
Costs
Discount factor 0.91 0.83 0.75 0.68
Discount factor 0.91 0.83 0.75 0.68
Discounted costs
Discounted costs

Benefits
Benefits
Discount factor 0.91 0.83 0.75 0.68
Discount factor 0.91 0.83 0.75 0.68
Discounted benefits
Discounted benefits

Discounted benefits - costs NPV

Discounted benefits - costs NPV
Cumulative benefits - costs
Cumulative benefits - costs

ROI
ROI
Payback In Year:
Payback In Year:

Estimated costs; $1,750,000 in year 1 and $400,000 each year in years 2, 3 and 4.
Estimated benefits; $0 in year 1, and $950,000 each year in years 2, 3, and 4.
Use a 10 percent discount rate.
 Another example
Financial
FinancialAnalysis
Analysis
for e-Learning Project 2006
for e-Learning Project 2006

Discount rate
Discount rate

YEARS: 1 2 3 4 Total
YEARS: 1 2 3 4 Total

Costs
Costs
Discount factor 0.91 0.83 0.75 0.68
Discount factor 0.91 0.83 0.75 0.68
Discounted costs
Discounted costs

Benefits
Benefits
Discount factor 0.91 0.83 0.75 0.68
Discount factor 0.91 0.83 0.75 0.68
Discounted benefits
Discounted benefits

Discounted benefits - costs NPV

Discounted benefits - costs NPV
Cumulative benefits - costs
Cumulative benefits - costs

ROI
ROI
Payback In Year:
Payback In Year:

Estimated costs; $2,500,000 in year 1 and $250,000 each year in years 2, 3 and 4.
Estimated benefits; $0 in year 1, and $750,000 each year in years 2, 3, and 4.
Use a 10 percent discount rate.
 Craig Brown
www.BetterProjects.net
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