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Hi
Brilliant website, brilliant lecturer. Thanks so much.
Can you please clarify how years 0 and 1 work for NPV calculations?
For example if we buy a machine on 01/01/2015, at the very beginning, then how do we define year 0? Is it the whole of 2015? Is year 1 then 2016, with 31/12/2016 being the assumed date for all year 1 cashflows? If it’s a 5 year project, does it run to 31/12/2019 so the end of year 4? Or to 31/12/2020, in which case it’s taking 6 years?! I am totally confused. Please explain.
Thanks again.
JamesThere is no such thing as ‘year 0’.
Time 0 is a point in time.
So if you buy a machine on 1 jan 2015 then this is time 0.
31 dec 2015 / 1 jan 2016 is 12 months later and is therefore time 1
(we are not bothered about 1 day – the whole purpose is to account for interest and effectively from 1 Jan 2015 to 31 Dec 2015/ 1 Jan 2016 will be one year of interest)Similarly, 31 Dec 2016 / 1 Jan 2017 is time 2 because it is 2 years away and so on.
Unless told differently we assume that operating cash flows (i.e. profit and loss items – revenue, running costs) occur at end of years.
So the first years revenue occurs at 31 Dec 2015 which is time 1
The second years revenue occurs at 31 Dec 2016 which is time 2
and so on 🙂Can I also ask a question with regards to NPV?
How would you calculate it if you are told that the revenues and costs occur evenly throughout the year for 7 years?
I was told not to calculate it for 12 months, instead just use the semi-annual discount factor.
That is fine that I use ^0.5 ^1.5 so on for the discount factor formula, but shall I put it in for the end of the years too? So I would have 14 periods… Is this correct? Thank you!In Paper FM we always assume that operating flows occur at the ends of years and therefore only discount for whole years.
If you were asked to discount for half years then you would do as you have written 🙂
Thank you very much! Yes I know, I couldn’t find any example with semi annual discount rates anywhere … 🙂
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