Pharmacoeconomics & Health Outcomes

The time value of money:

NET PRESENT VALUE

Leon E. Cosler, R.Ph., Ph.D.

Associate Professor of Pharmacoeconomics
Albany College of Pharmacy
Road Map

• Investing money and evaluating revenues

- Net present value (NPV)

• Implications and interpretation

- Internal Rate of Return (IRR)

• Implications and interpretation

The time value of money….
Today
(01/01/2008) 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013
? $ 100.00 $ 100.00 $ 100.00 $ 100.00 $ 100.00

You anticipate income of $100 annually for the

next 5 years starting one year from now.
Assume a discount rate of 5%...

What is the value of this income to you TODAY?

- called the NET PRESENT VALUE (NPV)
The time value of money….
Today
(01/01/2008) 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013
? $ 100.00 $ 100.00 $ 100.00 $ 100.00 $ 100.00

NPV = PV1 + PV2 + PV3 + PV4 + PV5

Net Present Value….

• You have choices where you can invest $$$

• You expect your current investment to have

future “returns”
- How do you know if your investment is “worth it” ?
- How do you pick from multiple investment options?

• Convert all future cash to their “Present Value”

and subtract your initial investment….
- Thus “Net Present Value”
Example…
• You want to start a new program in your
pharmacy. You are going to BORROW this
money from a bank @ 5% interest per year. You
will pay back the loan from the “new” revenue
you will earn.
• Should you borrow this money???
• Will you have money left over, or will you LOSE
money???
T oday
01/01/09 01/01/10 01/01/11 01/01/12 01/01/13
(01/01/2008)

C osts -$10,000 -$500 -$500 -$500 -$500 -$500

B enefits $0 $3,000 $3,000 $3,000 $3,000 $3,000
Net -$10,000 $2,500 $2,500 $2,500 $2,500 $2,500
The time value of money….

• 2 ways to handle these:

• NPV BENEFITS - NPV COSTS [overall]

• NPV (BENEFITS - COSTS) [each period]

• Costs to your business are NEGATIVE

• Revenues to your business are POSITIVE

The time value of money….

We can use the “net amount” each year

Today
1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013
(01/01/2008)

C osts -$10,000 -$500 -$500 -$500 -$500 -$500

B enefits $0 $3,000 $3,000 $3,000 $3,000 $3,000
Net -$10,000 $2,500 $2,500 $2,500 $2,500 $2,500

NPV = PV0 + PV1 + PV2 + PV3 + PV4 + PV5

Let’s look at this another way….

Today
1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013
(01/01/2008)
Balance Owed -$10,000.00 -$10,000.00 -$8,000.00 -$5,900.00 -$1,379.00
"Interest" $0.00 -$500.00 -$400.00 -$295.00 -$68.99
"NET NEW
$0.00 $2,500.00 $2,500.00 $2,500.00 $2,500.00
REVENUE"
Balance -$10,000.00 -$8,000.00 -$5,900.00 -$1,379.75 $1,051.26
What if the interest rate is 10% ?….

T oday
1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013
(01/01/2008)

C osts -$10,000 -$500 -$500 -$500 -$500 -$500

B enefits $0 $3,000 $3,000 $3,000 $3,000 $3,000
Net -$10,000 $2,500 $2,500 $2,500 $2,500 $2,500

NPV =

• How do I interpret this number?

The time value of money….

Internal Rate of Return (IRR)

- Investments that earn revenue are earning
you money at some rate of return…

It’s the rate at which:

NPV = 0

There are 2 ways to solve these:

1. “Guess!” ( interpolation )
2. Use a computer / calculator
The time value of money….
An example….

Today
01/01/08 01/01/09 01/01/10 01/01/11 01/01/12
(01/01/2007)

C osts -$10,000 -$500 -$500 -$500 -$500 -$500

B enefits $0 $3,000 $3,000 $3,000 $3,000 $3,000
Net -$10,000 $2,500 $2,500 $2,500 $2,500 $2,500

1. What can be said about the IRR of these

cash flows?
That’s all for today…