Chapter 15: Using Formulas for Financial Analysis
15
the rate period must be consistent with the payment period. In this example, the 8%
return you’d like is an annual return, and the payments are annual, so they match. If you
were getting a quarterly dividend, you would have to adjust the rate to a quarterly return.
FIGURE 15.21
The net present value of expected future cash flows
The NPV for these cash flows calculates to $33,068. Since the required investment to get
those cash flows, $30,000, is less than the NPV (and assuming the estimates are correct),
these would be good investments. In fact, this data shows that you would make something
more than the 8% return you wanted.
Calculating positive and negative cash flows
In the previous example, you were asked to make a large up-front investment to get future
cash flows. Another scenario where NPV can be used is when you make smaller payments at
the beginning of the investment period with the expectation of future cash inflows at the
end.
Instead of one $30,000 payment, assume that you would only have to invest $15,000 the
first year, $10,000 the second year, and $5,000 the third year. The amount you’re required
to invest goes down as the business grows and is able to use its own profits to grow. By year
4, no further investment is required, and it’s expected that the business will be profitable
enough to start paying a dividend.
Figure 15.22 shows a schedule where you pay in for the first three years and get money
back the last four. The NPV function is the same as before; only the inputs have changed.
=NPV(C2,C5:C11)