Question

Discuss the difference (you may use an example) between the calculation of present values of multiple cash flows and the calculation of net present value (NPV). Contrast the usefulness of Excel’s PV function and NPV function. Describe the difference between values returned by Excel’s NPV function and the actual calculation of NPV.

Answer 1

The difference between the present value and net present value is that initial outflow is subtracted from the total present value to get the net present value. Present value is the discounted value of future cash flow today while net present value is equal to the total discounted value today minus the outflow of cash. Let's say you invested $1000 at time period O, at time period 1 the value of your investment is $1200. The present value of $1200 discounted at 7% today would be 1121.50. This is the present value. The net present value would be 1121.50-1000 = 121.50. The NPV function of the excel is useful in calculating net present value when there are series of different cash flows occurring in future. For example, cash flows from a project over a 5-year period. The present value function in excel is more useful in calculating the present value when the series of cash flows occurring are same, like the cash flows of a bond or cash flows of loan payment. The NPV function in excel when used first asks for the discount rate and then it selects the series of cash flows occurring and then the cash outflow is subtracted from the function whereas if you are calculating the present value manually then you will have to discount the values of all the cash flows one by one to today's time period and then subtract the outflow of cash from the sum of the all the present value of future cash flows.