Chapter 4: Calculating the NPV of a Stream of Cash Flows

Page 80-81 of the 3rd edition of How to Measure Anything

This example shows the formulas you can use to calculate the net present value
(NPV) of a stream of cash flows. NPV is a way of computing a single value for a
series of payments over time. It takes into account the fact that money received
years later is not as valuable as money received this year. Money received later
is “discounted” to account for its lower value. This is called the “discount rate”
and it is why an NPV is also sometimes referred to as a “Discounted Cash Flow.”

Consider the following series of cash flows:

Year 1 Year 2 Year 3 Year 4 Year 5
Cash Flows $ 100,000 $ 5,000 $ 5,000 $ 5,000 $ 5,000 <= INPUT cash flows and interest rat
Interest Rate 10% or use provided values

Computing the NPV - with Excel and manually

NPV $ 105,318 <= Using Excel

NPV $ 105,318 <= Manually

sh flows and interest rate
e provided values
 Calculating the IRR of an Investment

Not shown in the book

This example shows how to use Excel's built-in formula to calculate the internal rate
of return (IRR). The IRR is the discount rate that results in the NPV of all cash flows
(in and out) being equal to zero. Generally, an investment with a high IRR is more
desirable than an option with a lower IRR if all other factors are equal. IRR is also
sometimes referred to as economic rate of return (ERR) and can be thought of as
the expected rate of growth generated from an investment.

Consider an investment with the following series of cash flows:

Year 1 Year 2 Year 3 Year 4 Year 5
Costs $100,000 $5,000 $5,000 $5,000 $5,000 <= INPUT costs, benefits, and
Benefits $0 $25,000 $125,000 $200,000 $250,000 cash flows or use provided
Net Cash Flow $100,000 $20,000 $120,000 $195,000 $245,000 values

Computing the IRR with Excel

IRR 83%
T costs, benefits, and
ows or use provided
values