Steps for computing NPV

Simple Steps for computing NPV:

1st Step: To find out Discount Rate:

This rate might be 8 or 9 percent or above according to the financial market condition.

2nd Step: To compute Present Value of Cash outflow or Initial Investment

It is computed just by multiplying cash outflow with the current value of discount rate. When we invest today, and then need not multiply since today investments means PV of Cash outflow.

3rd Step: To compute the Present Value of Cash inflows or gain before depreciation and after tax.

We can compute PV of cash inflows by multiply current value of discount rate.

PV of Cash inflows = Cash inflows X Factor Value of Discount Rate

(For illustration, when we have to receive today 0.90 $ rather than $ 1. Then it will automatically $ 1 after 1 year, therefore when we multiply this 0.90 $ with Cash inflow, then cash inflow will become the amount that we receive now not in future. )

4th Step: To compute Net Present Value

NPV = Present Value of Cash inflow – Present Value of Cash outflow

Calculation of NPV in case of Inflation:

In case of inflation, we have to find out real rate from nominal or discount rate and inflation rate.

In this part, the introduction about how to get total present value of cash flows if inflation rate is specified. It is very simple by employing excel formula. Assume that you have to purchase machine of 10 million dollars. This is cash outflow and then after 1 year you have to receive cash inflows. For computing net present value, you require real rate. When Nominal rate or discount rate is 11% and inflation is 5%, then you have to compute real rate in excel sheet by employing the formula given below:

Real rate = (1 + inflation rate) / (1 + inflation rate) – 1

Now we compute present value of cash inflow and present value of cash outflow on the base of real rate.

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