What is Net Present Value?

NPV or the Net Present Value is a simple yet essential tool that shows the difference between the present value of future cash flows and the amount of the current investment. The present value of your expected cash flow is derived by discounting them at a specific rate of return. NPV is a popular cash budgeting technique that is used to evaluate the suitability of investments and projects.

An in-depth understanding of this concept helps you to make sound investment decisions. In short, NPV is the result obtained after deducting the present value of cash outflow from the present value of cash inflow. It is a comprehensive evaluation technique as it takes into account the effect of time on the cash flows.

What is an NPV Calculator?

The net present value calculator is a simulation that shows you the value of an investment today. The calculator takes into account the expenses, revenue, and capital costs to determine the worth of an investment or a project. It helps you to determine if a project is worth the investment.

The NPV calculator consists of a formula box where you enter the initial investment, discount rate, and the number of years. You choose the nature of inflows, and the calculator will show you the present value of cash inflows and the net current value.

How does the NPV Calculator work?

The NPV calculator helps you to decide if an investment or a project is worth it. The net present value is calculated using the following formula:

NPV = [Cn/(1+r)^n], where n={0-N}

Where

Cn = Difference of cash flows
r = Discount rate
n = Time in years
You need to follow the selection criteria concerning the usage of the net present value. The calculation of NPV will result in three possible outcomes:

1. Positive NPV: In this situation, the present value of cash inflows is greater than the present value of cash outflows. This is an ideal situation for investment
2. Negative NPV: In this situation, the present value of cash inflows is less than the present value of cash outflows. This is not an ideal situation, and any project with this NPV should not be accepted.
3. Zero NPV: In this situation, the present value of cash inflows equals the present value of cash outflows. You may or may not accept the project.

Let’s understand how the NPV calculator works with an example. You have invested Rs 1.1 crore in a project which will last for five years. The estimated cash flow of the project is Rs 1 crore. The discount rate is 5%.

Nature of cash inflows = Yearly fixed cash inflow

As NPV is positive, the project or investment is worth it.

Nature of cash inflows = Yearly variable cash inflows.

How to use the ClearTax NPV Calculator?

The ClearTax NPV Calculator is a simulation that calculates the net present value of an investment. It helps you determine if the returns are worth the investment.

• Enter the initial amount that you plan to invest.
• You then enter the discount rate.
• Enter the number of years of the investment.
• You then select the nature of cash inflows as the yearly fixed cash inflows if the cash inflow is fixed.
• You must select the amount of the fixed cash inflows per annum.
• The ClearTax NPV Calculator will show you the present value of cash inflows and the net present value.
• You can select the nature of cash inflows as the yearly variable cash inflows if the cash inflow is variable.
• You then fill up the cash flow for each year.
• The ClearTax NPV Calculator will show you the present value of cash inflows and the net present value.

Benefits of using the ClearTax NPV Calculator?

• The ClearTax NPV Calculator helps you gauge the profitability of an investment before you put in the money.
• You can determine how much is money in the future, worth today.
• You get to know the opportunity cost of an investment. It helps you to plan the investments to earn inflation-beating returns.
• If you know the future value of your investments, you can save money and make better investment decisions.

What doesn’t NPV tell me?

NPV is a frequently used tool in the field of finance. But, NPV doesn’t tell you everything that you need to know to make the right investment.

a. NPV is based on a lot of assumptions and estimates. If any of the assumptions are wrong, you cannot gauge the true value of the investment.

b. NPV doesn’t take into account the risks inherent in an investment. It may lead to an overestimation of the cash flows, which can mislead the investors.

c. NPV ignores the possibilities of any escalations in the project cost in the future.

How is NPV different from IRR?

NPV is the difference between the present value of cash inflows and the present value of cash outflows. Internal Rate of Return (IRR) on the other hand, is the discount rate that equates the present value of cash inflows with the present values of cash outflows.

IRR is calculated by assuming that NPV is equal to zero. It shows the breakeven point or the point where there’s neither profit nor loss. Conversely, NPV shows the excess inflows over the outflows.