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## Net Present Value (NPV) (Discounted Cash Flow Measure) article

### NPV is the foundation of the discounted cash flow (DCF) process. With NPV you assume a discount rate (defined here as the yield you would like to get). The NPV is the amount you need to adjust the beginning amount (ie the purchase price) by so that the investment cash flows will give you that yield. The nature of the NPV is that it takes everything into account that made up the cash flow. The only weakness is that it is hard to calculate (not with planEASe, of course), and that it uses all the assumptions (which is where Sensitivity Analysis becomes incredibly useful). Start a 7 Day Free Trial

 Video Title: Learn about the Net Present Value (NPV) (Discounted Cash Flow Measure)Video Publication_Date: Thursday, September 21, 2017Video Duration: 9:00Video Description:Shows how the Net Present Value (NPV) is calculated, what factors are important, and how to use planEASe Sensitivity Analysis to find which assumptions affect the Net Present Value (NPV) most. The idea of the Net Present Value (NPV) is very important to commercial real estate investing.

 2010 2011 2012 2013 2014 2015 IRR Before Debt 1.5% 9.0% 9.9% 9.0% 9.5% 8.0% IRR Before Tax 9.2% 12.1% 9.5% 11.0% 7.0% IRR After Tax 6.5% 8.8% 6.6% 7.8% 4.6% NPV Before Debt @10.00% (\$246,299) (\$54,097) (\$8,769) (\$106,089) (\$66,107) (\$273,216) NPV Before Tax @10.00% (\$236,599) (\$16,136) \$56,761 (\$17,540) \$42,716 (\$146,603) NPV After Tax @10.00% (\$233,929) (\$68,875) (\$32,053) (\$121,655) (\$95,859) (\$265,158)

Determining what Discount Rate to use
A major difficulty with using Net Present Values in order to make investment decisions is determining what discount rate to use in the calculations. Theoretically, the proper discount rate is the rate at which alternative investments may be made. Thus, if a savings account is the investorâ€™s alternative, the six percent discount rate currently offered by the bank may be appropriate. Other investors may feel that they have different alternatives, however. For this reason, the individual investorâ€™s discount rate is an assumption in the analysis so that it may be varied for each investor. This difficulty in determining the proper discount rate is eliminated, however, when the investor uses the Internal Rate of Return to evaluate the investment.
Monthly Calculations
In the world of commercial real estate, cash flows occur monthly and the dollar amounts of the revenue and expense cash flows are almost always irregular. In the past there were mathematical games that were played to get the Net Present Value to reflect the monthly irregular cash flow, and you might still hear some of the old ways spoken of today, like "beginning or end of period" or "mid year convention" (Monthly vs Yearly IRR Discounted Cash Flow Measure Comparison). These tricks were necessary in a world where you typed individual cash flows into a calculator or spreadsheet. However, in the modern computing world there is no need for these mathematical tricks, because computers are now fast enough to handle the present value discounting process on a monthly basis. The initial process for computing NPV in Excel and other spreadsheets made the assumption that the cash flows occurred annually and at the end of the year. With the new speed of computers, it became feasible to compute NPV more accurately by including the date of the cash flow as well as the amount. This new (and much more accurate) method of computation is known within Excel (and other spreadsheets) as the XNPV function. Here are links to descriptions of the XNPV process:
XNPV Verification
If you are interested how to verify the monthly NPV look to this page Verify Monthly IRR and NPV Using Excel or Google Spreadsheets XIRR and XNPV. Also there is a "Net Present Value Report" shown at the end of this article that has all the monthly information to use for the verification. The NPV's shown in the proforma examples will be very slightly different than the true XNPV process show in the planEASe Cash Flow Utility, Excel XNPV, and Google Spreadsheet XNPV because the NPV's shown in the Proforma Samples do not use leap years, so in a six years analysis there can be 1 or 2 days difference in time length.
Net Present Value NPV Considers:
• All assumptions entered such as: Scheduled Income, Purchase Price, Down Payment, Current Debt Payment, Vacancies, Expenses, Property Taxes, Lease terms, Revenue Growth, Rent Control, Expense Growth, Property Tax Growth, Deferred Maintenance, Debt Amount (Ratio), Interest Rate, Interest Rate Changes, Payment Changes, Points, Prepayment Penalties, Depreciation, Capital Expenditures, Income Taxes, \$25,000 Exemption, Passive Losses, Appreciation, Capital Gains Tax ... and all other entered assumptions
Net Present Value NPV Ignores:
• Only assumptions not entered

Why is Net Present Value NPV useful?
NPV is the foundation of the discounted cash flow (DCF) process. With NPV you enter a discount rate which is the yield you would like to get. The NPV is the amount you need to adjust the beginning amount (ie purchase) by to equal that yield. The nature of the NPV is that it takes everything into account that made up the cash flow. The only weakness is that it is hard to calculate (not with planEASe of course), and that it uses all the assumption values (so, in turn, you are required to enter these assumptions, which means more work on your part).
The Net Present Value NPV is shown in these planEASe reports:
Net Present Value Report
Retail - Office

These cash flows and dates are those on which the Net Present Value Before Tax in the planEASe analysis of the Retail - Office are based.

planEASe Software plans operating cash flows monthly, and assumes that cash flows occuring during the month all occur at the middle of the month.Calculators and Spreadsheets typically schedule these cash flows at the end of the year (year-end convention).Since cash flows do actually occur unevenly during the year, the mid-month convention is more accurate.

The Net Present Value (NPV) of the Cash Flows shown in the table below, when discounted at 10.0000% to 1 Jan 2010 is (\$146,597.42). One interpretation of this NPV is that you must pay \$146,597.42 less on 1 Jan 2010 for the right to receive the cash flows shown, if you want a 10.0000% Internal Rate of Return on your total investment.

 Date Years Cash Flow Present Value Discount Factor Present Value at 10.0000% 1 Jan 2010 0.00 (\$1,023,343.86) 1.0000000 (\$1,023,343.86) 16 Jan 2010 0.04 2,236.82 0.9960908 2,228.08 15 Feb 2010 0.12 2,236.82 0.9883182 2,210.69 18 Mar 2010 0.21 2,236.82 0.9803502 2,192.87 17 Apr 2010 0.29 2,236.82 0.9727004 2,175.76 17 May 2010 0.37 2,236.82 0.9651103 2,158.78 17 Jun 2010 0.46 2,236.82 0.9573295 2,141.37 17 Jul 2010 0.54 (9,710.70) 0.9498593 (9,223.80) 17 Aug 2010 0.62 5,457.26 0.9422014 5,141.84 16 Sep 2010 0.71 5,457.26 0.9348493 5,101.72 17 Oct 2010 0.79 5,457.26 0.9273124 5,060.58 16 Nov 2010 0.87 5,457.26 0.9200765 5,021.10 17 Dec 2010 0.96 5,457.26 0.9126587 4,980.62 16 Jan 2011 1.04 5,780.60 0.9055371 5,234.55 15 Feb 2011 1.12 5,780.60 0.8984711 5,193.70 18 Mar 2011 1.21 5,780.60 0.8912275 5,151.83 17 Apr 2011 1.29 5,780.60 0.8842731 5,111.63 18 May 2011 1.38 5,780.60 0.8771440 5,070.42 17 Jun 2011 1.46 5,780.60 0.8702995 5,030.85 18 Jul 2011 1.54 5,861.79 0.8632830 5,060.38 17 Aug 2011 1.62 5,861.79 0.8565467 5,020.90 16 Sep 2011 1.71 5,861.79 0.8498630 4,981.72 17 Oct 2011 1.79 5,861.79 0.8430113 4,941.56 16 Nov 2011 1.87 2,917.39 0.8364332 2,440.20 17 Dec 2011 1.96 3,015.14 0.8296897 2,501.63 16 Jan 2012 2.04 (6,618.04) 0.8232155 (5,448.07) 16 Feb 2012 2.13 (107,129.28) 0.8165786 (87,479.48) 17 Mar 2012 2.21 5,169.26 0.8102068 4,188.17 17 Apr 2012 2.29 5,169.26 0.8036748 4,154.40 17 May 2012 2.38 5,169.26 0.7974036 4,121.99 16 Jun 2012 2.46 5,169.26 0.7911814 4,089.82 17 Jul 2012 2.54 5,419.56 0.7848027 4,253.29 16 Aug 2012 2.62 5,419.56 0.7786788 4,220.10 16 Sep 2012 2.71 5,419.56 0.7724010 4,186.07 16 Oct 2012 2.79 5,419.56 0.7663739 4,153.41 16 Nov 2012 2.88 5,419.56 0.7601953 4,119.92 16 Dec 2012 2.96 5,499.99 0.7542634 4,148.44 15 Jan 2013 3.04 5,524.26 0.7483778 4,134.23 15 Feb 2013 3.13 5,877.88 0.7423442 4,363.41 17 Mar 2013 3.21 5,877.88 0.7365516 4,329.36 17 Apr 2013 3.29 5,877.88 0.7306134 4,294.46 17 May 2013 3.38 5,877.88 0.7249124 4,260.95 17 Jun 2013 3.46 5,877.88 0.7190680 4,226.60 17 Jul 2013 3.54 797.32 0.7134570 568.85 17 Aug 2013 3.63 954.15 0.7077050 675.26 16 Sep 2013 3.71 5,856.27 0.7021827 4,112.17 16 Oct 2013 3.79 5,856.27 0.6967035 4,080.08 16 Nov 2013 3.88 5,856.27 0.6910866 4,047.19 16 Dec 2013 3.96 5,939.12 0.6856940 4,072.42 16 Jan 2014 4.04 5,963.88 0.6801658 4,056.43 15 Feb 2014 4.13 6,328.11 0.6748584 4,270.58 18 Mar 2014 4.21 6,328.11 0.6694176 4,236.15 17 Apr 2014 4.29 6,328.11 0.6641940 4,203.09 17 May 2014 4.38 6,328.11 0.6590112 4,170.30 17 Jun 2014 4.46 6,328.11 0.6536982 4,136.67 17 Jul 2014 4.54 6,328.11 0.6485973 4,104.40 17 Aug 2014 4.63 6,454.84 0.6433682 4,152.84 16 Sep 2014 4.71 6,454.84 0.6383479 4,120.43 17 Oct 2014 4.79 6,454.84 0.6332015 4,087.21 16 Nov 2014 4.88 6,454.84 0.6282605 4,055.32 17 Dec 2014 4.96 3,039.44 0.6231954 1,894.17 16 Jan 2015 5.04 (7,757.88) 0.6183325 (4,796.95) 15 Feb 2015 5.13 (3,974.88) 0.6135076 (2,438.62) 18 Mar 2015 5.21 (3,974.88) 0.6085614 (2,418.96) 17 Apr 2015 5.29 (3,974.88) 0.6038128 (2,400.08) 18 May 2015 5.38 (75,114.05) 0.5989447 (44,989.16) 17 Jun 2015 5.46 8,703.63 0.5942711 5,172.32 18 Jul 2015 5.55 8,703.63 0.5894800 5,130.62 17 Aug 2015 5.63 8,834.17 0.5848802 5,166.93 16 Sep 2015 5.71 8,834.17 0.5803163 5,126.61 17 Oct 2015 5.79 8,834.17 0.5756377 5,085.28 16 Nov 2015 5.88 8,834.17 0.5711459 5,045.60 17 Dec 2015 5.96 8,834.17 0.5665413 5,004.92 31 Dec 2015 6.00 1,370,777.84 0.5644739 773,768.35 TOTALS \$481,767.24 (\$146,597.42)

Written by
Michael Feakins, CCIM
of planEASe Software