Net present worth

Net present worth (NPW) Estimated net cash flow in year n (NFW)... 

Discounted cash-flow analysis, used to calculate the present worth of future earnings (Section 6.10.3), is sensitive to the interest rate assumed. By calculating the NPW for various interest rates, it is possible to find an interest rate at which the cumulative net present worth at the end of the project is zero. This particular rate is called the discounted cash-flow rate of return (DCFRR) and is a measure of the maximum rate that the project could pay and still break even by the end of the project life. 

Inflation depreciates money in a manner similar to, but different from, the idea of discounting to allow for the time value of money. The effect of inflation on the net cash flow in future years can be allowed for in a similar manner to the net present worth calculation given by equation 6.9, using an inflation rate in place of, or added to, the discount rate r. However, the difficulty is to decide what the inflation rate is likely to be in future years. Also, inflation may well affect the sales price, operating costs and raw material prices differently. One approach is to argue that a decision between alternative projects made without formally considering the effect of inflation on future earnings will still be correct, as inflation is likely to affect the predictions made for both projects in a similar way. 

Net present worth NPW , As for NFW but accounts for timing of cash flows Dependent on discount rate used... 

Calculate the cumulative net present worth of the project, at a discount rate of 8 per cent. Also, calculate the discounted cash flow rate of return. 

Number of years for the net Present worth of receipts less IRR equals the interest rate i... 

Cash flow is the amount of funds available to a company to meet current operating expenses. Cash flow may be expressed on a before- or after-tax basis. After-tax cashflow is defined as the net profit (income) after taxes plus depreciation. It is an integral part of the net present worth (NPW) and discounted cash flow profitability calculations. 

Net Present Worth In the net present worth method, an arbitrary time frame is selected as the basis of calculation. This method is the measure many companies use, as it reflects properly the time value of money and its effect on profitability. In equation form... 

Net Present Worth Method The NPW method allows the conversion of all money flows to be discounted to the present time. Appropriate interest factors are applied depending on how and when the cash flow enters a venture. They may be instantaneous, as in the purchase of capital equipment, or uniform, as in operating expenses. The alternative with the more positive NPW is the one to be preferred. In some instances, the alternatives may have different lives so the cost analysis must be for the least common multiple number of years. For example, if alternative A has a 2-year life and alternative B has a 3-year hfe, then 6 years is the least common multiple. The rate of return, capitalized cost, cash flow, and uniform annual cost methods avoid this complication. 

An article by J. Linsley, Return on Investment Discounted and Undiscounted, Chern. Eng., 86(11) 201 (May 21, 1979), suggests that return on investment can be defined as net, after-tax profit plus depreciation divided by capital investment. This definition of return on investment where depreciation cash flow is included as part of the return is not used in this book, instead, this method of handling cash flow is included in the profitability methods reported for discounted-cash-flow Profitability Index and Net Present Worth. 

In the preceding treatment of discounted cash flow, the procedure has involved the determination of an index or interest rate which discounts the annual cash flows to a zero present value when properly compared to the initial investment. This index gives the rate of return which includes the profit on the project, payoff of the investment, and normal interest on the investment. A related approach, known as the method of net present worth (or net present value or venture worth), substitutes the cost of capital at an interest rate i for the... 

To illustrate the method for determining net present worth, consider the example presented in Table 1 for the case where the value of capital to the company is at an interest rate of 15 percent. Under these conditions, the present value of the cash flows is 127,000 and the initial investment is 110,000. Thus, the net present worth of the project is... 

Work Sheet for Calculating Present Value and Net Present Worth... 

Line 13 gives the annual cash flows for each of the operating years with the zero-year column giving only the total capital investment. In line 16, the present value of the annual cash flows to the project is obtained by summing the individual present values for each year of operation including the present value of the working-capital and salvage-value recovery at the end of the service life. Line 17 merely applies the definition of net present worth as used in this text as the difference between the total present value of the annual cash flows to the project and the initial required investment. 

Work sheet for presenting discounted-cash flow, present-value, and net-present-worth determinations ... 

Net present worth = total present value of annual cash flows -... 

It is quite possible to compare a series of alternative investments by each of the profitability measures outlined in the early part of this chapter and find that different alternatives would be recommended depending on the evaluation technique used. If there is any question as to which method should be used for a final determination, net present worth should be chosen, as this will be the most likely to maximize the future worth of the company. 

For investments 2 and 3, the present values of the cash flows to the projects are determined from the first two equations under part (c) of this problem, with i 0.15. The resulting net present worth are ... 

The greatest net present worth is found for investment No. 3 therefore, investment No. 3 should be recommended. 

The same methods that were explained and applied earlier in this chapter are applicable for replacement analyses. Net-present-worth and discounted-cash-flow methods give the soundest results for maximizing the overall future worth of a concern. However, for the purpose of explaining the basic principles of replacement economic analyses, the simple rate-of-retum-on-investment method of analysis is just as effective as those methods involving the time value of money. Thus, to permit the use of direct illustrations which will not detract from... 

Check the values given for the discounted-cash-flow rate of return and net present worth. If the company requires a minimum rate of return of 10 percent, which system should be chosen ... 

Year Discounted cash-flow rate of return Net present worth at 10%... 

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