To calculate the net present value of a single cash flow, it is divided by one plus the interest rate for each period of time that will pass. This is expressed mathematically as raising the divisor to the power of the number of units of time.
For example: You want to find the net present value of $100 that will be received in five years time. What is it worth now? What amount of money, if you let it grow at at the discount rate, would equal $100 in five years?
We will assume a 12% per year discount rate.
NPV = 100 dollars divided by 1 plus 12% divided by 1 plus 12%, etc.
The discount rate used in financial calculations is usually chosen to be equal to the cost of capital. Some adjustment may be made to the discount rate to take account of risks associated with uncertain cashflows.
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