Net Present Value

NPV= Summation of PVs- Initial Investment

If there’s one cash flow from a project that will be paid one year from now, then the
calculation for the NPV of the project is as follows:

𝑁𝑃𝑉 =
( 𝐶𝑎𝑠h 𝑓𝑙𝑜𝑤
( 1+𝑖 ) 𝑡
)
−𝑖𝑛𝑖𝑡𝑖𝑎𝑙𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 i- required return or interest rate
t- number of time periods
If analyzing a longer-term project with multiple cash flows, then the formula for the NPV of
the project is as follows:
𝑛
𝑅𝑡 - net cash inflow- outflows during a single period t
𝑁𝑃𝑉 =∑ i- discount rate or return that could be earned in alternate investments
𝑡 =0 (1+𝑖)𝑡 t- number of time periods

Year Amount discount factor PV

0 -100 Initial investment
1 20 0.926 18.52
2 25 0.857 21.43
3 30 0.794 23.81
4 35 0.735 25.73 NPV= Total PV- Initial investment
5 40 0.681 27.22 =>116.72-100= 16.72
116.72
Hurdle rate: It is the minimum required rate of return a project must achieve before a investor
approves a pre-determined condition

The hurdle rate describes the appropriate compensation for the level of risk present—riskier projects
generally have higher hurdle rates than those with less risk.

Hurdle rate= Weighted Average Cost of Capital(WACC) + Risk premium

WACC calculation: Outstanding

Value of common stock outstanding WACC Calculation amount (INR)
Interest rate Cost (INR)
Value of preferred stock outstanding
Common Stock 1,15,00,000 11% 12,65,000
Value of total debt
Interest rate on each Preferred Stock 15,00,000 7% 1,05,000
Debt 62,50,000 5% 3,12,500
Suppose risk premium is 4%
Total 1,92,50,000 8.74% 16,82,500
Then,
Hurdle rate is 8.74% + 4%= 12.74%

Hence, if the rate of return is estimated to be above 12.74%, then investment can be made, if not,
then it is better to not move forward.