The present value , 379.08, is the value today of the investment.

In a competitive market, the present

value should correspond to the market price of the cash fl ows. The spreadsheet illustrates three
ways of obtaining this value: • Summing the individual present values in cells C5:C9. To simplify the
copying, note the use of “ ∧ ” to represent the power and the use of both the relative and absolute
references; for example: = B5/(1 + $B$2) ∧ A5 in cell C5. • Using the Excel NPV function. As we show
on the next page, Excel ’ s NPV function is unfortunately misnamed—it actually computes the
present value and not the net present value. 15 Basic Financial Calculations • Using the Excel PV
function. This function computes the present value of a series of constant payments. PV(B2,5,-100) is
the present value of 5 payments of 100 each at the discount rate in cell B2. The PV function returns a
negative value for positive cash fl ows; to prevent this unfortunate occurrence, we have made the
cash fl ows negative. 2 The Difference Between Excel ’ s PV and NPV Functions The above
spreadsheet may leave the misimpression that PV and NPV perform exactly the same computation.
But this is not true—whereas NPV can handle any series of cash fl ows, PV can handle only constant
cash fl ows: 1 2 3 4 5 6 7 8 9 10 11 12 13 A BC D etar tnuocsiD %01 Year Cash flow Present value
Present value of each cash flow 1 5A^)2$B$+1(/5B= --<-- =SUM(C5:C9) Using Excel's NPV function
1065.26 <-- =NPV(B2,B5:B9) COMPUTING THE PRESENT VALUE In this example the cash flows are not
equal Either discount each cash flow separately or use Excel's NPV function Excel's PV doesn't work
for this case Excel ’ s NPV Function Is Misnamed! In standard fi nance terminology, the present value
of a series of cash fl ows is the value today of the future cash fl ows: Present value CF r t t t N = = ( ) +
∑1 1 2. This strange property—returning negative values for positive cash fl ows—is shared by a
number of otherwise impeccable Excel functions such as PMT and PV. The somewhat convoluted
logic which led Microsoft to write these functions this way is not worth explaining. 16 Chapter 1 The
net present value is the present value minus the cost of acquiring the asset (the cash fl ow at time
zero): Net present value CF r CF t t t N CF = ( ) + = = ↑ < ∑0 1 0 0 0 In many cases me , aning that it
represents the price paid for the asset. + CFt =1 ( ) 1+ ↑ ′ ∑ r t t N This is the present value given by
Excel s NPV , function. Excel ’ s language about discounted cash fl ows differs somewhat from the
standard fi nance nomenclature. To calculate the fi nance net present value of a series of cash fl ows
using Excel, we have to calculate the present value of the future cash fl ows (using the Excel NPV
function), taking into account the time-zero cash fl ow (this is often the cost of the asset in question).
The Net Present Value, NPV Suppose that the above investment is sold for $400. Clearly it would not
be worth its purchase price, since—given the alternative return (discount rate) of 10%—the
investment is worth only $379.08. The net present value (NPV) is the applicable concept here.
Denoting by r the discount rate applicable to the investment, the NPV is calculated as follows: NPV CF
CF r t t t N = + = ( ) + 0 ∑1 1 where CF t is the investment ’ s cash fl ow at time t and CF0 is today ’ s
cash fl ow. Suppose, for example, that the series of 5 cash fl ows of $100 is sold for $250. Then, as
shown below, the NPV = 129.08. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 A BC D etar tnuocsiD %01 Year Cash
flow Present value 0 -250 -250.00 <-- =B5/(1+$B$2)^A5 1 6A^)2$B$+1(/6B= --<-- =SUM(C5:C10)
Using Excel's NPV function 129.08 <-- =B5+NPV(B2,B6:B10) COMPUTING THE NET PRESENT VALUE 17
Basic Financial Calculations The NPV represents the wealth increment of the purchaser of the cash fl
ows. If you buy the series of 5 cash fl ows of 100 for 250, then you have gained 129.08 in wealth
today. In a competitive market the NPV of a series of cash fl ows ought to be zero: Since the present
value should correspond to the market price of the cash fl ows, the NPV should be zero. In other
words, the market price of our 5 cash fl ows of 100 ought—in a competitive market, assuming that
10% is the correct risk-adjusted discount rate—be 379.08. The Present Value of an Annuity—Some
Useful Formulas 3 An annuity is a security which pays a constant sum in each period in the future.
Annuities may have a fi nite or infi nite series of payments. If the annuity is fi nite, and the
appropriate discount rate is r , then the value today of the annuity is its present value: PV of finite
annuity C r C r C r C r r n n = + + ( ) + +…+ ( ) + = − ( ) + ⎛ ⎝ ⎜ ⎜ ⎜ ⎞ 1 1 1 1 1 1 2 ⎠ ⎟ ⎟ ⎟ If the
annuity promises an infi nite series of constant future payments, then this formula reduces to: PV of
infinite annuity C r C r C r = + + ( ) + +…= 1 1 2 Both of these formulas can be computed with Excel.
Below we compute the value of a fi nite annuity in three ways: using the formula (cell B6), using Excel
’ s PV function (cell B7), and using Excel ’ s NPV function: 3. All the formulas in this subsection
depend on some well-known but oft-forgotten high school algebra. 18 Chapter 1 1 2 3 4 5 6 7 8 9 10
11 12 13 14 15 16 A B C C ,tnemyap cidoireP 000,1 Number of future periods paid, n 5 r ,etar
tnuocsiD %21 Present value of annuity alumrof gnisU 4B/)3B^)4B+1(/1-1(*2B= --<--
=NPV(B4,B10:B14) COMPUTING THE VALUE OF A FINITE ANNUITY 1 2 3 4 A B C C ,tnemyap cidoireP
000,1 r ,etar tnuocsiD %21 ytiunna fo eulav tneserP 3B/2B= --< C r g g r , provided 1 1 1 These
formulas can easily be implemented in Excel. Below we compute the value of a fi nite growing
annuity using the formula above and using Excel ’ s NPV function: