Does the NPV function in Excel correspond to the financial definition of net present value? Explain your answer.

Question

What will be an ideal response?

Answer 1

?The financial definition of net present value is the difference between the present value of a series of future cash flows and the current value of the initial investment. One source of confusion for Excel users is that despite its name, the NPV function does not return the net present value of an investment. Instead, it returns the investment's present value based on the returns that the investment will provide in the future. To calculate the net present value in Excel, the initial cost of the investment must be added to the present value of the returns from the investment using the formula =initial investment + NPV value whereinitial investmentis the initial cost of the investment andNPV valueis the value of Excel's NPV function applied to future returns. The initial investment is assumed to have a negative cash flow because that investment is being purchased, and it is assumed to be based on current, not future, dollars. The exception to this formula occurs when the initial investment also takes place in the future. For example, if the initial investment takes place in one year and the returns occur annually after that, then the NPV function will return the net present value without having to be adjusted because the initial investment is also paid with discounted dollars.