The NPV formula is a way of calculating the Net Present Value (NPV) of a series of cash flows based on a specified discount rate. The NPV formula can be very useful for financial analysis and financial modeling when determining the value of an investment (a company, a project, a cost-saving initiative, etc.).
Below is an illustration of the NPV formula for a single cash flowCash FlowCash Flow (CF) is the increase or decrease in the amount of money a business, institution, or individual has. In finance, the term is used to describe the amount of cash (currency) that is generated or consumed in a given time period. There are many types of CF.
In most cases, a financial analyst needs to calculate the net present value of a series of cash flowsForecasting Cash FlowThis article on forecasting cash flow is the last part of the four-step financial forecasting model in Excel. Having completed our income statement and balance sheet forecasts, we can now turn to the cash flow statement to complete the four-step forecast modeling framework. By the end of this article, you will be able, not just one individual cash flow. The formula works in the same way, however, each cash flow has to be discounted individually, and then all of them are added together.
Here is an illustration of a series of cash flows being discounted:
Below is a short video explanation of how the formula works, including a detailed example with an illustration of how future cash flows become discounted back to the present.
DCF Modeling
The main use of the NPV formula is in Discounted Cash Flow (DCF) modeling in Excel. In DCF modelsDCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business. DCF stands for Discounted Cash Flow, so the model is simply a forecast of a company’s unlevered free cash flow discounted back to today’s value. This free DCF model training guide will teach you the basics, step by step with examples and images an analyst will forecast a company’s three financial statementsThree Financial StatementsThe three financial statements are the income statement, the balance sheet, and the statement of cash flows. These three core statements are intricately linked to each other and this guide will explain how they all fit together. By following the steps below you'll be able to connect the three statements on your own. into the future and calculate the company’s Free Cash Flow to the FirmValuationFree valuation guides to learn the most important concepts at your own pace. These articles will teach you business valuation best practices and how to value a company using comparable company analysis, discounted cash flow (DCF) modeling, and precedent transactions, as used in investment banking, equity research, (FCFF). Additionally, a terminal valueTerminal ValueThe terminal value is used in valuing a company. The terminal value exists beyond the forecast period and assumes a going concern for the company. is calculated at the end of the forecast period. Each of the cash flows in the forecast and terminal value are then discounted back to the present using a hurdle rateHurdle Rate DefinitionA hurdle rate is the rate of return that must be achieved before accepting and funding an investment project. Hurdle rates are used in financial modeling to calculate NPV. If IRR > Hurdle Rate then the investment creates value. The rate is determined by assessing the cost of capital, risks involved, opportunity cost of the firm’s weighted average cost of capital (WACCWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. The WACC formula is = (E/V x Re) + ((D/V x Rd) x (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator).
Thank you for reading this guide to calculating net present value. CFI’s mission is to help anyone become a world-class financial analyst. To keep learning and advancing your career, these additional financial resources will be a big help:
Walk me through a DCF modelWalk me through a DCFThe question, walk me Through a DCF analysis is common in investment banking interviews. Learn how to ace the question with CFI's detailed answer guide. Build a 5-year forecast of unlevered free cash flow, calculate a terminal value, and discount all those cash flows to present value using WACC.
Valuation methodsValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions. These methods of valuation are used in investment banking, equity research, private equity, corporate development, mergers & acquisitions, leveraged buyouts and finance
DCF modeling guideDCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business. DCF stands for Discounted Cash Flow, so the model is simply a forecast of a company’s unlevered free cash flow discounted back to today’s value. This free DCF model training guide will teach you the basics, step by step with examples and images
