×QvantCase
← All techniques

Finance · level 2

NPV of a short cash-flow strip

Learn three discount factors by heart for the rate in play and an NPV becomes three multiplications and a subtraction. At 10% they are 0.91, 0.83 and 0.75.

Theory: Time Value of Money

Worked example: Invest $7M today; receive $4M, $2M, $5M in years 1–3. NPV at 12%?

year 1$4M → $3.57M
year 2$2M → $1.59M
year 3$5M → $3.56M
NPV$1.72M

Step by step

  1. 1

    Year 1

    $4M × 0.89 = $3.57M

  2. 2

    Year 2

    $2M × 0.8 = $1.59M

  3. 3

    Year 3

    $5M × 0.71 = $3.56M

  4. 4

    Sum the present values

    $8.72M

  5. 5

    Less the outlay

    − $7M → NPV $1.72M

  6. 6

    Decision

    Positive NPV — the project clears the hurdle.

Invest $7M today; receive $4M, $2M, $5M in years 1–3. NPV at 12%? = 1,724,718

The theory behind it

Intuition

NPV is value created after paying for the capital used. Positive means the project beats the next-best alternative at equal risk.

Common pitfalls

  • ×Including sunk costs.
  • ×Ignoring changes in working capital, which are real cash.

In the interview

The final 'so should they do it?' number in an investment case.