## Net Present Value Method

the net present value method of investment appraisal can be helpful to assess the value of investment projects and to compare the value of different projects.

## How to Calculate Net Present Value of an Investment?

The NPV calculation is one method of comparing the expected return on a project with the expected cost. It is generally used to decide whether to invest in a project, but it is also used for investment appraisal.

NPV calculation also can be used to compare the expected return on a project with the expected cost when there is no option to invest, and that is where the name comes from. That’s because the NPV is the same as the NPV of the only investment.

## Example of NPV Calculation

Watson manufacturing has an opportunity to invest $96,000 in a new machine. The new machine will result in cost savings of $25,000 in year 1, $25,000 in year 2, $25,000 in year 3, $25,000 in year 4, and $25,000 in year 5.

The new machine will require a tune-up in year 3 costing $3,000. The salvage value of the machine will be $10,000 at the end of year 5. Watson’s cost of capital is 10%. Create a table showing the cash flows in each year of the project and compute the NPV.

Year | 0 | 1 | 2 | 3 | 4 | 5 |

Outflows | (96000) |
(3000) | ||||

Inflows | 25000 | 25000 | 25000 | 25000 |
35000 | |

Net CF | (96000) | 25000 | 25000 | 22000 | 25000 |
35000 |

Dis. factor | 1 | 0.909 | 0.826 | 0.751 | 0.683 |
0.621 |

(96000) | 22,725 | 20650 | 16522 | 17075 |
21735 |

NPV = 22725+20650+16522+17075+21735 – 96000 = $2707

The NPV is: $2707, hence the investment acceptable.