Question

NPV calculations can be done on financial calculators, software and in Excel. Excel has an NPV function key which assists in obtaining the NPV of the project after entering the cash flows and discount rate. Why am I using the word “assists”?   What is wrong if I said it provides the NPV by using that function key?

Answer 1

Excel NPV function doesn't provides NPV but it assists in its calculation.

This can be explained with an example.

Suppose there is a project which requires cash outflow of $50,000 today and provides cash inflow of $20,000 for 5 years and the discount rate is 10%.

Now the problem with NPV function is that it doesn't take into account the cash flows at year 0 i.e today.

If you would select a cash flow range in the NPV function, excel would assume that the first cell in the range is cash flow at year 1 and not year 0.

So, to calculate NPV, we calculate the present value of cash inflows using the NPV function and then subtract the cash outflow at year 0.

Since we had to use an extra function i.e. subtracting the cash outflow at year 0, the NPV function only assists in NPV calculation rather than providing NPV.

The next image shows the calculation of NPV using NPV function -

=NPV(10%,C3:07) A B с р year Nm + 2 3 cash flow $ 20,000 $ 20,000 $ 20,000 $ 20,000 $ 20,000 $ 75,815.74 $ 50,000 $ 25,815.74 0 0 present value of cash inflows less: initial cash outflow net present value

As you can see, we have calculated the present value of cash inflows using NPV function and then subtracted the initial outflow to calculate net present value (NPV).

In this way, NPV function only assisted in NPV calculation rather than providig it.