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This document allows the user to calculate the net present value (NPV) and internal rate of return (IRR) of a certain investment. Net present value allows the business to consider the time value of money by adding the discounted cash flows less the initial investments. The IRR is the rate of return at which the present value of future cash inflows equals zero. The user should enter the initial investment, the discount rate, and any future cash inflows. The spreadsheet will then automatically calculate the present value, cumulative present value, net present value, and IRR.
NET PRESENT VALUE AND INTERNAL RATE OF RET Net present value allows the business to consider the time value of money by adding the discounting cash flows less the initial investments. The approach is useful in determining whether the present value of future cash inflow can justify project investment. If discounted present value of future cash inflow minus the initial project cost outlay is zero, or greater than zero, this will indicate the future cash inflows can justify the decision on whether to invest in the project. The total present value of discounted cash inflows less initial project cost is what is referred as net present value of a project. A negative net present value indicates a project should be rejected or if it is a business being purchased the price should be renegotiated to reflect a present value which is not less than a zero. The discounting rate is selected by the business owners or investors and it is the required rate of return, the minimum rate a business owner is willing to accept as return for a given risk. Different business will have different required rate of return. Another rate widely used in discounting cash flows is the cost of Internal Rate of Return (IRR) is the rate of return which makes the present value of future cash inflows equate to zero. The internal rate of return shows the equivalent dollar amount of interest rate the project will produce for the amount invested in a project. The rate should be compared with rate of other similar projects or the business cost of borrowing capital. The higher the IRR the more the project is valuable and therefore a project with a higher IRR should be selected in expense of the projects with lower IRR. By entering the cash inflow and initial cash outflow, excel computes the rate of return of the project. The keyed in discount rate is used to discount the cash flows for the purpose of computing the net present value for each year. The calculation of internal rate of return can allow a business to evaluate how long it will take the business to produce cash flows to equate to the net present value. This can help a business plan on debt arrangement which reflects on the number of years needed to pay off debt obligation. Because of the element of discounting future cash flows, the evaluation of project is based on value of a future dollar on today’s rate. The business is able to evaluate sensible projects to ensure resources are well utilized to create wealth for the owners. Project evaluation and planning are based on the principles of business faces capital constrains and a project is selected in expense of the other. The Net present value and Internal rate of return evaluates the projects based the value the projects adds to the business net worth. TE OF RETURN INTERNAL RATE OF RETURN AND NET PRESENT VALUE Initial Outlay/Investment 1,000.00 Discounting Rate 7% IRR (Internal Rate Of Return) #NUM! Cumulative Year Cash Inflow Present Value Present Value Initial Outlay/Investment (1,000.00) 1 0 0 2 0 0 3 0 0 4 0 0 5 0 0 6 0 0 7 0 0 8 0 0 9 0 0 10 0 0 11 0 0 12 0 0 13 0 0 14 0 0 15 0 0 16 0 0 17 0 0 18 0 0 19 0 0 20 0 0 21 0 0 22 0 0 23 0 0 24 0 0 25 0 0 26 0 0 27 0 0 28 0 0 29 0 0 30 0 0 URN AND NET PRESENT VALUE Net Present Value (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00)
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