The Top 10 definitions used in a Net Present Value Investment Analysis Decision.

The Top 10 definitions used in a Net Present Value Investment Analysis Decision.

Category: Profitability, Viability, Revenue, Pricing, Cash Flow (AN19)

Originally Submitted on 4/10/97.

When setting up a Net Present Value analysis, you need to define the following ten factors in order to proceed with the calculation.

1. Time value of Money: the value assigned to money at different points in time recognizing that money today is valued differently than money in the future. Due to the delay in gratification, money in the future is assumed to be more valuable and money in the present must be discounted to represent accurately the instant gratification gained by consumption in the present.

This is done through using the discount rate/hurdle rate to find or calculate a "discount factor." Present and Future Value Tables are available for discount factors already calculated for your use according to your rate of interest used. In the case of an annuity you need to know the number of years in the planning horizon to cross reference the discount factor.

2. Present Value: the value today that must be invested at x% to reach a value in the future.

Usually the amount of your investment in a lump sum amount. The amount of money you intend to invest.

3. Future Value: the value in the future of today's amount at x% compounded over a specific period of time.

This amount is usually the amount you are trying to calculate from the analysis. However, if you were trying to reach a future target and it was known, you could derive the present value required through analysis.

4. Discount Rate/Hurdle Rate: the % either calculated through IRR or agreed to as a rate of return the investment alternative must equal or exceed..

5. Inflation Rate: the overall expected inflation rate which must be indexed to the discounting factors either before or after they are applied to create discounted future cash flows.

6. Opportunity Cost: the amount of return in % that can be achieved through an alternative employment of capital.

7. Incremental Costs: those costs that come as a result of a particular investment choice.

8. Tax Consequences: those factors which will affect the net earnings, depreciation, amortization and other outcomes of positive or negative cash flows. (Possibly, after dispersement of the earnings or allocation of the losses.)

9. Planning horizon: the period of time used to consider the life of the cash flows from the investment.

10. Cash Flow: the amount of money left over after all costs are removed in a planning period.

About the Submitter

This piece was originally submitted by Mike R. Jay, coach, consultant, writer, thinker, who can be reached at topten@leadwise.com, or visited on the web. Mike R. Jay wants you to know: that he appreciates your time and attention. If you have any comments or constructive criticism please drop him an e-mail at the above address. The original source is: research@leadwise.

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