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Return on Investment – Net Present Value Method

Return on Investment – Net Present Value Method. By R. S. Miolla. Agenda. 1) What is return on investment (ROI)? 2) Time value of money concept. 3) Net Present Value Method. 1) ROI or Capital Budgeting. Answers: Is this a good financial investment? A long-term investment

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Return on Investment – Net Present Value Method

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  1. Return on Investment – Net Present ValueMethod By R. S. Miolla

  2. Agenda • 1) What is return on investment (ROI)? • 2) Time value of money concept. • 3) Net Present Value Method.

  3. 1) ROI or Capital Budgeting • Answers: Is this a good financial investment? • A long-term investment • Example: buying equipment, opening a plant • Based on cash flows, not earnings • Statement of cash flows not the income statement

  4. 2) Time Value of Money • The idea that cash received today is worth more than cash in the future. • An investment is made today- cash out. • Return is earned in the future- cash in. • Discount rate is a %. • PV = FV/(1+i)^n • PV = 100 (.826) = $82.60; n=2, i=10% • Use an online financial calculator (Investopedia)

  5. Investment Defined • $10,000 cash outflow (investment) • Cash inflows: • Investment A Investment B • Year 1 6000 2000 • 2 4000 2000 • 3 2000 2000 • 4 0 3000 • 5 0 4000

  6. Net Present Value Method – Investment A • The firm needs to pick a discount rate: 10% • Year 1 6000 x .909 = 5454 • Year 2 4000 x .826 = 4130 • Year 3 2000 x .751 = 1502 • Total NPV of inflows: 11086 • NPV of the project: 11,086 – 10,000 = 1086

  7. Net Present Value Method (NPV) – Investment B • Year 1 2000 x .909 = 1818 • 2 2000 x .826 = 1652 • 3 2000 x .751 = 1502 • 4 3000 x .683 = 2049 • 5 4000 x .621 = 2484 • NPV of inflows 9505 • NPV of the project: 9,505 – 10,000 = (495)

  8. Summary • 1) Return on investment. • 2) Time value of money concept. • 3) Net Present Value Method.

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