Difference between revisions of "Net Present Value"

Revision as of 19:46, September 10, 2007

Net Present Value is a method to estimate the current value of future cash flows. In its simplest form, Net Present Value applies a discount rate to a future cash flow number and the product is the Net Present Value.

The discount rate may have many components; Internal Rate of Return (IRR), Cost of Capital, Cost of Debt, Risk, and so on.

@@ Line 3: / Line 3: @@
 The discount rate may have many components; Internal Rate of Return (IRR), Cost of Capital, Cost of Debt, Risk, and so on.
-Let's consider a simple example.  Suppose, ignoring Shakespeare's advice I lent $100.00 each to two friends of mine, due one year from today.
-One friend calls up and asks me how much will I accept from him if he pays today.  Because I am getting currenlty getting 5.27% on my invesments, and this fiend is almost risk free (he is conservative) I tell him I will accept $95.00.  This $95.00 is the Net Present Value of the $100.00 owed to me.  The discount rate I used was my IRR.
-My other friend, a Wikipedia editing liberal also owes me $100.00 one year from now.  Fearing he will contribute all his money to left wing candidates in the upcoming election, I call him and tell him I will clear of his debt if he gives me $90.00 today.  My discount rate, now 10%, includes the original IRR but also an additional factor for risk.
-Note then, that while the lender (me) and the product (money loan) remained the same, the discount factor, hence present value, can and will change.
 [[Category:finance]]

Difference between revisions of "Net Present Value"

Revision as of 19:46, September 10, 2007

Navigation menu

Search