How to Calculate the Net Present Value (NPV) of a Capital Investment

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How can you identify the most financially attractive investment? Make the right choice and your business will bloom with new revenue and added value. Make the wrong choice and you will spend years untangling from an unwise investment and incurring substantial financial losses.

You must do the math!  There are three primary ways to calculate an investment return.  We’ve already looked at ROI and IRR.

The easiest and most common method to evaluate a business investment is by calculating a static pro forma return on investment (ROI).  The pro forma return calculation looks at what will be when the investment is fully operational or stabilized.

The Internal Rate of Return (IRR) calculation takes into account the time value of money.  The IRR calculation takes a series of investment inflows and capital outflows and returns the average annual rate of return over the investment period to yield a zero net present value (NPV).

And a third method is net present value.

Net Present Value (NPV) is the cousin of IRR. The differences are with IRR you solve for the average annual return to get a zero NPV while the NPV calculation shows the value in today’s dollars from a series of future investment flows. You need to determine the annual discount rate to solve for the net present value for your investment opportunity. This involves substantial guesswork and is prone to error so be careful when selecting the discount rate to apply to future cash flows.

Choose carefully from among your investment options during your financial planning process. You have a finite amount of disposable cash for growth opportunities. Your strategic investment plan should include a calculation of return on investment (ROI), net present value (NPV), and internal rate of return (IRR) for each business opportunity.

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About Michael Shelton

Your Business Coach Facilitating Delegation and Work Group Engagement Michael Shelton has over twenty-five years of business and military accomplishments, including extensive experience with one of the largest, publicly traded real estate investment trusts (REIT). He is a qualified business coach with assignments in cross-functional work group management, strategic planning, unit leadership, joint venture acquisitions, executive education, mentoring, training and merger integration. Michael has accumulated best practices for building committed work groups from more than $4 billion of capital markets transactions and commercial property development. He served as a commissioned officer and helicopter pilot in the U.S. Army, and earned his MBA from The University of Arizona. Michael has served as a major conference panelist and is the author of Cash Flow Rich, Winning Ways to Evaluate and Finance Real Estate. Today, he helps business owners get more work group engagement as President and CEO of Shelton Business Services, LLC in Scottsdale, Arizona. Disclaimer: I don't offer investment, legal or tax advice. Talk to your broker, accountant or lawyer for investment, tax and legal help. I might own stock in the companies I mention on-line. My posts, tweets and other on-line activity are my personal thoughts and don't represent my employer or company.
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