What is Net Present Value?

Definition of Net Present Value

Net Present Value is a way of determining the value of a project. It is simply the Present Value of a series of cash flows. Before we talk more about that, we should review the concepts of the time value of money, Present Value, Future Value, and the Discount Rate.

Time Value of Money

One dollar today is more valuable than one dollar in a year. The reason is due to inflation. The reason is also due to the fact that a dollar today can be invested, therefore you earn additional money on that dollar. The idea that money in the present is more valuable than money in the future is the time value of money.

Present Value and Future Value

If someone offers you the choice of getting a dollar now or a dollar a year from now, people will always take the dollar now. In order for someone to take the money the money in the future, they have to offer more than a dollar. That one dollar in the present is the Present Value. The dollar amount in the future is the Future Value.

The Discount Rate

The Discount Rate is the multiplier used to turn the Present value to the Future value. For example, if the discount rate is 5% per year, that means $1.00 today is worth $1.05 in one year. The formula to express this idea is Future Value = Present Value * (1+Discount Rate)Number of years. If you wish to calculate things in the other direction it’s Present Value = Future Value * (1+Discount Rate)-Number of Years. The Net Present Value is simply what amount of cash now is equal to the sum of all the cash that you receive in the future.

Calculation Example:

Let’s say a project lasts for 3 years. Each year the project earns $10,000. The discount rate is 10%. You want to know what the Present Value is of the project. The first year you make $10,000, which has a Present Value of $10,000/1.1 or $9090.91. The second year you make you make $10,000, which has Present Value of $10,000/(1.12) or $8264.46. The third year you make $10,000, which has a present value of $10,000/(1.13) or $7513.15. The Net Present Value is $9090.91 + $8264.46 + $7513.15, or $24,868,52.

Investment Fee Structure

Rate Assets Under Management
1.44% Below $125,000
1.00% Between $125,000 and $750,000
.85% Between $750,000 and $1,250,000
.80% Between $1,250,000 and $1,750,000
.75% Between $1,750,000 and $2,500,000
.70% Between $2,500,000 and $3,250,000
.65% Between $3,250,000 and $4,250,000
.60% Above $4,250,000

A single rate is applied to the entire account. So a person with a $750,000.01 account pays less than a person with a $750,000 account. I will waive personal tax return fees for accounts over $1 million. For accounts that are above $5,250,000, we’ll need to discuss a custom rate. 

As I’m writing these to help my readers, I would be very appreciative of any input in regards to what I should write next. If you want me to write about a particular topic, please contact me. Please contact me if you would like to submit a post to my blog.

If anything that I mentioned above interests you, please consider downloading my free e-book. The book contains my thoughts on investment management and some information that I think everyone should know. You can also download it below.

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Questions for the comments

Did my explanation make sense? Do you agree or disagree with what I said?

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