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Hello! Im really confused on the calculation of the present value.
Firstly, how do I calculate the present value of an uneven cash flows?
What is the formula and steps required?For example, a project duration is 5 years & discount rate is 12%. The initial outlay is $500. Net contribution is $140. And residual value for the fifth year is $100. Ignore tax.
Am I correct for using this method?
Cash flow:
First year = $140
Second = $140
Third = $140
Fourth = $140
Fifth = $240140 [1/(1.12)1] + 140 [1/(1.12)2] + 140 [1/(1.12)3] + 140 [1/(1.12)4] + 240 [1/(1.12)5]
= 561.41Also, how do I calculate the present value interest factor?
What is the formula and steps required?.
You get given a present value table in the exam – use these where possible rather than calculate it yourself. See here for the formula you get given:
What you need to do to calculate an NPV is to lay everything out in a table. Start with years at the top and include 0. You may have to include an extra year or 2 at the end if working with tax and tax allowable depreciation.
Add lines for the various cash flows to your table and sum them to the total cash flow for the year. You then copy the discount rate from the table and multiply them together to get the present value of the cash flow. Then sum them up and you have the NPV.
In your method above you have missed out an important part – the year 0 outlay of 500. This is not discounted as it happens immediately.
You can’t calculate a complex NPV without using a table – there’s far too much going on to calculate it in a one line formula.
A question C answer in spreadsheet form should end up looking something like this:
What Chris has written is all completely correct.
But can I also add that you could save time by using the annuity discount factors (which are also given in the exam) on the $140 per year, and then use the normal present value factor on the $100 in the 5th year.
I really do suggest that you watch my free Paper F2 lectures on investment appraisal, because this really is a basic Paper F2 question (and far too simple a question for Paper F9).
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