PMP - Understand PV & NPV (Concept)

Present Value (PV):

Present Value or PV is the value of the investment in today's terms. It is the value of future cash flows of the project in today's dollars.

This is a discounted cash flow technique and one of the Benefit Measurement Methods under the Project Selection Methods tool and technique which is used for creating a Project Charter.

Ouch, that was quite long. To repeat, the Project Charter creation process uses a tool and technique called Project Selection Methods. One of the techniques under the Project Selection Method is Discounted Cash Flow which calculates Present Value.

The formula for calculating a Present Value is

PV = FV/(1 + i)ⁿ

where

PV - Present Value to be calculated

FV - Expected Future Cash inflow

i - Notional Interest or Expected Rate of Interest

Net Present Value:

This is another interesting twist to calculate the Net future income/future cash inflow of the project in today's dollars. There is no big difference or additional concept to remember here. This is just a sum of all the expected Present values subtracted by the investment. For example, if we assume that the following are the given values.

Invested Amount : $5,00,000

Income Expected (Future Value)- 1 Year : $200000

Income Expected (Future Value)- 2 Year : $300000

Income Expected (Future Value)- 3 Year : $100000

Rate of Interest : 5% per annum 

Now calculate the Present value for every year with the Present Value (PV) formula.

Year	Future Value	Calculation	PV
1	$200000	2,00,000/(1 + .05)	190476.2

2	$300000	3,00,000/(1 + .05)2	272108.84

3	$100000	3,00,000/(1 + .05)3	86383.76

Total NPV (For 3 years) = 5,48,968.8

NPV for the project = Total NPV (For 3 years) - Original Investment = 5,48,968.8 - $5,00,000

So the final NPV is 48,968.8.

And the formula for calculating the Net Present Value is,

NPV = PV₁ + PV₂+ PV₃ .. + PV_n - Invested Amount

According to the theory of NPV if the calculation of NPV yields a positive value or more than zero, then it is expected to make profit. It can get a go recommendation if all other factors look good. Additional points to remember are like,

• NPV assumes that the cash flows are re-invested at the cost of capital. ie, the same interest rate
• If NPV calculation is greater than zero accept the project. Otherwise reject the project
• Another note is that projects with high returns early in the project are preferred over the ones with lower returns early in the project.