Project A requires a capital investment of $2,000 and promises a payment of $1,000 at the end of Years One, Two, and Three. If the investor's required rate of return is 12%, what is the NPV of the investment? We can use the NPV formula with the values CF 1, CF2,and CF3 = $1,000, CF 0 = $2,000, T = 3, and R = 0.12.

NPV = CFt[1/ (1 + R)]t ­ CF

NPV = $1,000[1 / (1.12)]1 + $1,000[1 / (1.12)]2 + $1,000[1 / (1.12)]3 - $2,000
NPV = $1,000[0.8929] + $1,000[0.7972] + $1,000[0.7118] - $2,000
NPV = $401.83

Using the
financial
calculator

To solve for NPV with your financial calculator, enter each of the cash flows and capital investments in their proper order. Enter the discount rate of 12% and push the NPV key to get $401.83. Project A has a positive net present value.

Analyzing
opportunity cost
for use of funds

Some analysts use net present value to determine if the cash flows are sufficient to repay the capital investment plus an amount for the opportunity cost of using the company's funds. A positive NPV means that the project is able to repay the initial investment, pay the opportunity cost for the use of the funds, and generate additional funds that create value for the company; a negative NPV means that the project cannot generate enough funds to cover the original investment and the opportunity cost for the use of the funds.

Practice what you have learned about calculating the net present value of an investment by completing the Practice Exercise that begins on page 5-13; then continue to the section on "Internal Rate of Return".