NPV calculation?

Question

i have some difficulty calculating NPV.

a building was built 20 years ago with cost of $400k,40years life 0salvage.

the building produces $100k rental per year. with 5% increase per year.

how do i calculate the NPV? no interest is given

Answer 1

You need a dsicount/cost of capital rate to complete the NPV calc.  In this case i spose u can assume that 5% is the rate and carry on.

Answer 2

The NPV is the sum of the present values of each year minus the initial investment.

You are assuming a $100k initial investment with 5% increase per year for the next 20 years. The cost in year zero is 400k.

What you have not told us is the discount rate. For company's the discount rate is usually 10-12% (operational costs, administrative costs, etc). For individuals, the discount rate is often placed at 4%.

Calculating the NPV manually for 20 years is not hard, but it is time consuming. You would have to calculate the Future value of the 100k (+5% per year) in each given year. The Present Value can be calculated by:

PV = FV x 1/(1+r)^t

FV = Future Value

PV = Present Value

r = discount rate

t = time

For simplicity's sake let us assume a discount rate of 5%. This would essentially allow us to ignore the 5% increase per year as well as the discount rate in our calculations. The NPV would then be the present value for each of the years calculated individually and summed up minus the initial investment. You can use excel or a 3rd party program to do this.

Your NPV for 20 years would be:

(100k x 20) - 400k = 1.6 million.

If you raise the discount rate from 5% or reduce the increase per year to less than 5% the returns will reduce. Also bear in mind that NPV is usually calculated over a few years (3-7...often 5). Calculating the NPV over 20 years will skew your results.

The NPV for your product over 7 years with a 5% increase each year and a 5% discount rate is only $300k. If you raise the discount rate your NPV could easily go into the negatives over a shorter span.

Additionally, your payback period (when you get back the nominal value of your invested dollars) is nearly 4 years. Generally you should be careful when planning for return on investment beyong the 5-7 year period.