CALCULATION NET PRESENT VALUE USING FORMULA

NPV = C * {(1 - (1 + R) ^ -T) / R} − Initial Investment

where C is the expected cash flow per period, R is the required rate of return and T is the number of periods over which the project is expected to generate income.

For example, consider two potential projects for company ABC:

Project X requires an initial investment of $35,000 but is expected to generate revenues of $10,000, $27,000 and $19,000 after the first, second and third years, respectively. The target rate of return is 12%. Since the cash inflows are uneven, the second formula listed above is used.

NPV = {$10,000 / (1 + 0.12) ^ 1} + {$27,000 / (1 + 0.12) ^ 1} + {$19,000 / (1 + 0.12) ^ 1} - $35,000
NPV = $8,929 + $21,524 + $13,524 - $35,000
NPV = $8,977

Project Y also requires a $35,000 initial investment and will generate $27,000 per year for two years. The target rate remains 12%. Because each period produces equal revenues, the first formula above can be used.

NPV = $27,000 * {1 - (1 + 0.12) ^ -2} - $35,000
NPV = $45,631 - $35,000
NPV = $10,631

Despite the fact that both projects require the same initial investment and Project X actually generates more total income than Project Y, the latter project has a higher NPV because income is generated faster, meaning the discount rate has a smaller effect.