You have been asked by a manager in your organization to put together a training
ID: 2631061 • Letter: Y
Question
You have been asked by a manager in your organization to put together a training program explaining Net Present Value (NPV) and Future Value (FV) and how they are used to evaluate the price of stock. You have been given the following objectives:
Upon completing your Net Present Value (NPV) and Future Value (FV) Training Program, employees should be able to do the following:
Develop a 10- to 12-slide PowerPoint Presentation (excluding title slide and reference slide) that cover each of the above topics. In the slide notes, include your explanations for each topic above
Explanation / Answer
Net present value is a calculation that compares the amount invested today to the present value of the future cash receipts from the investment. In other words, the amount invested is compared to the future cash amounts after they are discounted by a specified rate of return.
For example, an investment of $500,000 today is expected to return $100,000 of cash each year for 10 years. The $500,000 being spent today is already a present value, so no discounting is necessary for this amount. However, the future cash receipts of $100,000 for 10 years need to be discounted to their present value. Let's assume that the receipts are discounted by 14% (the company's required return). This will mean that the present value of the those future receipts will be approximately $522,000. The $522,000 of present value coming in is compared to the $500,000 of present value going out. The result is a net present value of $22,000 coming in
For example, an investment of $1,000 today at 10 percent will yield $1,100 at the end of the year; therefore, the present value of $1,100 at the desired rate of return (10 percent) is $1,000. The amount of investment ($1,000 in this example) is deducted from this figure to arrive at net present value which here is zero ($1,000-$1,000). A zero net present value means the project repays original investment plus the required rate of return. A positive net present value means a better return, and a negative net present value means a worse return, than the return from zero net present value. It is one of the two discounted cash flow techniques (the other is internal rate of return) used in comparative appraisal of investment proposals where the flow of income varies over time.
Future value (FV) refers to a method of calculating how much the present value (PV) of an asset or cash will be worth at a specific time in the future.
How it works/Example:
There are two ways of calculating future value: simple annual interest and annual compound interest. Future value with simple interest is calculated in the following manner:
Future Value = Present Value x [1 + (Interest Rate x Number of Years)]
For example, Bob invests $1,000 for five years with an interest rate of 10%. The future value would be $1,500.
Future Value = $1,000 x [1 + (0.1 x 5)]
Future Value = $1,000 x 1.5
Future Value = $1,500
Future value with compounded interest is calculated in the following manner:
Future Value = Present Value x [(1 + Interest Rate) Number of Years]
For example, John invests $1,000 for five years with an interest rate of 10%, compounded annually. The future value of John's investment would be $1,610.51.
Future Value = $1,000 x [(1 + 0.1)5]
Future Value = $1,000 x 1.61051
Future Value = $1,610.51
It is important to remember that simple interest is always based on the present value, whereas compounded interest means that the present value grows exponentially each year.
Factors used in NPV:
The present value factor formula is based on the concept of time value of money. Time value of money is the idea that an amount received today is worth more than if the same amount was received at a future date. Any amount received today can be invested to earn additional monies
Present value = future value * (1/(1+r)^n
R = rate of interest and n is the number of period.
Factors used in FV:
The future value factor formula is based on the concept of time value of money. The concept of time value of money is that an amount today is worth more than if that same nominal amount is received at a future date. Any amount received today can be invested and receive earnings, as opposed to waiting to receive the same amount with no earnings. An amount of $105 to be received a year from now may be okay if the individual wants $100 today, assuming that the individual can earn 5% otherwise in one year.
Future value factor = (1+r)^n
R = rate per period and n = number of periods.
Purpose of NPV
The NPV is a metric that is able to determine whether or not an investment opportunity is a smart financial decision. NPV is the present value (PV) of all the cash flows (with inflows being positive cash flows and outflows being negative), which means that the NPV can be considered a formula for revenues minus costs. If NPV is positive, that means that the value of the revenues (cash inflows) is greater than the costs (cash outflows). When revenues are greater than costs, the investor makes a profit. The opposite is true when the NPV is negative. When the NPV is 0, there is no gain or loss
Purpose of FV:
The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today. There are two ways to calculate FV:
1) For an asset with simple annual interest: = Original Investment x (1+(interest rate*number of years))
2) For an asset with interest compounded annually: = Original Investment x ((1+interest rate)^number of years)
The Relationship Between Present and Future Value:
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