Net Present Value Analysis

Net Present Value Analysis

• Net Present Value (NPV) is a method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.
• NPV means the return from a project exceeds the opportunity cost of capital — the return available by investing the capital elsewhere.

Steps for Manually Calculating NPV

• Determine the estimated costs and benefits for the life of the project and the products it produces.
• Determine the discount rate, which is the rate used in discounting future cash flows.
• Calculate the net present value by subtracting the total discounted costs from the total discounted benefits.

Return on Investment (ROI)

• ROI is the result of subtracting the project costs from the benefits and then dividing by the costs.
• ROI is always a percentage, and the higher the ROI, the better.
• Many organizations have a required rate of return for projects — the minimum acceptable rate of return on an investment.
• The internal rate of return (IRR) can be found by finding what discount rate results in an NPV of zero for the project.

Payback Analysis

• Payback analysis is used to evaluate projects based on how long it takes to recover the initial investment.

Weighted Scoring Models

• A weighted scoring model is a tool that provides a systematic process for selecting projects based on many criteria.
• To create a weighted scoring model:
  • Identify criteria important to the project selection process.
  • Assign a weight to each criterion (so they add up to 100 percent).
  • Assign numerical scores to each criterion for each project.
  • Calculate the weighted scores by multiplying the weight for each criterion by its score and adding the resulting values.