Description
Please reply to both POST1 and POST2 in at least 200 words each.
It should be noted that POST1 and POST2 include the professor comments and what he thought of POST1 and POST2. This could prove helpful when forming your response.
POST1:
“NPV
can recognize the time value of money” (Panova, 2018). Net Present
Value is future cash flows discounted by the initial investment. Cash
flows occur at regular intervals (although periods may be different) and
may vary in amount (Frye, 2017). While projects in the early stages may
have negative outflow, if successful, outflow will turn positive.
The formula to determine net present value is as follows: NPV=(cashflows)/(1+r)i.
Determining the discounted cash flow and net present value of a
potential project is critical in project management. According to Panova
(2018), “the assessment of the construction risks is considered as a
prerequisite for their mitigation. For the estimation of those risks,
one of the most important capital-budgeting models is applied, for
example, net present value (NPV)” and discounted cash flow (DCF).
Once the discounted cash flow is assessed, an organization can
subtract their initial investment amount from the discounted cash flow
to calculate the net present value of the project and determine its
profitability.
The following steps will assist with creating an excel worksheet to calculate NPV:
1. First open a new excel worksheet
2. Column A, row 1 – name cell: Rate of Return
3. In column B, row 1 insert the determined rate and change the number format to percentage
4. Column A, row 2 name cell “period”
5. Column B, row 2, name cell “cash flow”
6. Column A, row 3, name cell “0” – the initial investment cost
7. Column A row 4, name “1” – the 1st cash flow amount
8. Column A, row 5, name “2” – the 2nd cash flow amount
9. Column A, row 6, name “3” – the 3rd cash flow amount*
10.
Proceed to input initial investment cost into cell Column B, row 3.
Input dollar amount with a (-) and change number format to accounting
11. Input 1st, 2nd, and 3rd cash flow amounts into column B, row 4, 5, and 6, changing number format to accounting
12. Column A, row 7, name NPV
13. Column B, row 7, input following:
=NPV(B1,B4:B6)+B3
Press enter
You can also think about it like:
=NPV(rate of return, 1st-3rd cash flows)+initial investment
*number of periods is determined by the projected cash flow and can vary
For example, a NPV problem covered in a previous course asked to
determine the NPV of a five year construction project with an initial
investment of $50,00 a projected net cash flow of $25,000, $35,000,
$45,000, $20,000, and $15,000. The required rate of return in 20%. Using
the above steps, the following excel spreadsheet was created.
Rate 20.00%
Period Cash Flow
0 $(50,000.00)
1 $25,000.00
2 $35,000.00
3 $45,000.00
4 $20,000.00
5 $15,000.00
NPV $36,853.78
Frye, C. (2017). Introduce Net Present Value and Rate of Return. Retrieved from
https://www.linkedin.com/learning/excel-analyzing-and-visualizing-cash-flows/introduce-net-present-value-and-internal-rate-of-return?u=2245842 (Links to an external site.)
Panova, Y., & Hilletofth, P. (2018). Managing supply chain risks and delays in construction
project. Industrial Management & Data Systems, 118(7), 1413–1431. https://doi.org/10.1108/IMDS-09-2017-0422
Professors response to post1
Talla,
Your review of net present value is right on the money. Of all the
economic models we use in the process of determining the efficacy of a
candidate project it seems the first stop is NPV. I agree with this as
our desire is to know and understand which project will turn us the best
outcome. NPV will give us that understanding. Even if all the projects
we are considering render a positive NPV, our question is which gives us
the best outcome.
POST2:
Net
Present Value (NPV) is used in determining the value of money in the
future (a set number of years) to the value of money today. Read any
article on NPV and you are likely to see some accompanying phrase like
“a dollar today is more valuable than a dollar in the future.” The
reason for this is because the money an organization has available
(liquidity) today can be put to immediate use in generating more money.
Additionally, as goods and services increase in price due to inflation,
year after year, the value of money (buying power) is reduced
(Martinelli & Milosevich, 2016).
To determine if a particular project makes financial sense for an
organization to undertake, one might use an NPV calculation. The Excel
spreadsheet I have attached shows the short way to calculate NPV
(highlighted in yellow) and the long way to calculate NPV (highlighted
in light blue). I believe using both methods is a great way to ensure
the calculations are correct.
Stice and Stice (2015), in their video presentation on “The net present value (NPV) method”, identified five steps in calculating the NPV:
- Determine the expected cash flow and the timing of each cash flow.
(This is an estimation/assumptions on the amount of money either coming
in or out of the investment over a set number of years. This step
requires experience and sound judgment in estimating potential project
returns) - Evaluate the risk of the cash flows to determine the discount rate
(Many organizations will already have a required rate of return, also
known as the hurdle rate, established for estimators and project
managers to use) - Calculate present values for all expected cash inflows and outflows
(Referring to the Excel attachment, divide the cashflow by 1+hurdle rate
and the year the cash flow is expected in; example: [20,000/(1+.20)^4]) - Subtract the total present value of cash inflows by the present
value of the cash outflows (Taking the total discounted cashflow and
subtracting any cash outflows and the initial investment = NPV) - Decide whether to undertake the investment (if the NPV shows a
positive or zero than the project is considered acceptable from a
financial standpoint, meaning the earnings gained by the project exceeds
the cost in present dollars)
While the project may have a positive Net Present Value, a
quantitative analysis should not be the sole deciding factor in
determining whether a project is acceptable. Evaluating the viability of
any project should also take into account the qualitative factors and
organizational goals.
Martinelli, R. J., & Milosevich, D. Z. (2016). Project management toolbox: Tools and techniques for the practicing project manager (2nd ed.). Hoboken, NJ: John Wiley and Sons.
Stice, J. D., & Stice, E. K. (2015, September 8). The net present value (NPV) method
[Video file]. Retrieved from
https://www.linkedin.com/learning/accounting-foundations-managerial-accounting/the-net-present-value-npv-method?u=2245842.
Professors response to POST2
Michael,
Looks to me like your did a great job of determining where this
candidate project might come up in the future point. If it is a positive
return you will accept the project as a viable job for the company. I
am agreeing. I like the approach that you took to calculate the NPV. Is
this the approach you see where you work, or did this come from the LI
video?
Either way, the NPV is a great way to determine the economic value of
the project. When we recommend to our company the projects we would
think viable and positive for engaging, NPV is one of our tools. The IRR
and Payback Period will also be required.
