Part Two Net Present Value Method Net present value (NPV) is one method that can be used to evaluate the fihancial viability of potential projects. It determines the present value of all future cash flows associated with potential projects and measures this against the cost of the project. To use net present value, a required rate of return must be defined. The required rate of return is the minimum acceptable rate of return that an investment must yield for it to make sense economically. Managers often choose a required rate of return above their cost of capital to ensure that the inherent uncertainties surrounding future cash flows is addressed. This can be risky, however, as it biases the process toward short-term projects. If the NPV is positive, then the project should be accepted ; if it is negative, then the project should be rejected Let's look at a net present value example using the present value of an ordinary annuity table. The company has a project with a 5-year life that requires an initial investment of $210,000, and is expected to yield annual cash flows of $64,000. What is the net present value of the project if the required rate of return is set at 12%? Calculation Steps Present Value of an Annuity of $1 at Compound Interest. Net Present Value = ($ Note: Round your answer to the nearest whole dollar. What NPV does the previous calculation yield? $ Based on the NPV computed above, what is indicated? 1. The project is profitable Check My Work Next > Let's look at an example of internal rate of return calculation with even cash flows. A company has a project with a 4-year life, requiring an initial investment of $196,400, and is expected to yield annual cash flows of $58,000. What is the internal rate of return? IRR Factor = Investment Annual cash flows IRR Factor: This is the factor which investment: This is the present you'll use on the table for the value of cash outflows associated present value of an annuity of $1 with a project. If all of the dollar in order to find the percentage investment is up front at the which corresponds to the internal beginning of the project, the rate of return. present value factor is 1.000. Annual Cash Flows: This is the amount of cash flows to be received annually as a result of the project. Calculation Steps Present Value of an Annuity of $1 at Compound Interest. IRR Factor = IRR Factor - , rounded to 6 decimals rounded to 6 decimals The calculated factor corresponds to which percentage in the present value of ordinary annuity table? Check My Work Next >