Example
A corporation must decide whether to introduce a new product line. The new product will have startup costs, operational costs, and incoming cash flows over 12 months. This project will have an immediate (t=0) cash outflow of 100,000 (which might include machinery, and employee training costs). The monthly net income is depicted in the income statement sheet each for months 1–12. All values are after-tax, and the required rate of return is 10%. The present value (PV) can be calculated for each month:
| Month | Cash flow | Present value |
|---|---|---|
| T=0 | -100,000 | |
| T=1 | -49701.81818 | |
| T=2 | -32364.46281 | |
| T=3 | 2294.515402 | |
| T=4 | 4868.51991 | |
| T=5 | 16098.62714 | |
| T=6 | 16278.29919 | |
| T=7 | 23650.43135 | |
| T=8 | 35956.52284 | |
| T=9 | 19816.38532 | |
| T=10 | 29629.77288 | |
| T=11 | 46381.55871 | |
| T=12 | 52907.69139 |
The sum of all these present values is the net present value, which equals 65,816.04. Since the NPV is greater than zero, it would be better to invest in the project than to do nothing, and the corporation should invest in this project if there is no alternative with a higher NPV.
More realistic problems would need to consider other factors, generally including the calculation of taxes, inflation, currency exchange fluctuation, uneven cash flows, and salvage value as well as the availability of alternate investment opportunities.
Read more about this topic: Net Present Value
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