NPV and IRR Model

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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
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.
                                                 INTERNAL RATE OF RETURN AND NET PRESENT VALUE
Initial Outlay/Investment             1,000.00

Discounting Rate                            7%

IRR (Internal Rate Of Return)       #NUM!

              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

           Net Present Value

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