Thursday, May 5, 2011

430. REA Examination - Net Present Value etc.

It is difficult for the lecturer to explain Net Present Value in real estate investment, part of the REA examination syllabus.

I got some info from ROI For Nonprofits by Tom Ralser

Chapter 8. Suggested Methodologies For Developing nonprofit ROI scenarios. The result allows the value of the outcome to be shown.

PRESENT VALUE BASICS

Situations can present value of future benefits e.g. enhanced earning potential for high school graduates or changed to present value of the costs avoided eg. disease prevention value. They involve the time value of money, a discoutn rate that reflects the risk and cost of funds and a series of cash flows.

CASH FLOWS
are periodic (usually annual) outlays required to get the nonprofit project underway and inflows (benefits) expected over the life of the project.

e.g. Cost at time zero = $100,000
Cash flow at time zero = -$100,000

DISCOUNt RATES
are like interest rates in reverse. The cash flows need to be brought back to the present day at a discount rate, with the present value being smaller. In present value terms, an apples-to-apples comparison can be made. The actual cost of money used for the project is also included.



NET PRESENT VALUE

Present value becomes net present value when the initial cost is included which is usually a negative flow. The basic formula is:


NPV = Sum (n)/t=0 CF1/(1+k)power of 1

where CDF=cash flow at period t and k is the cost of capital or the cost of money for the organisation.

In English, Net Present Value (NPV) is the sum of all of the periodic cash flows brought back to today at the appropriate discount rate.

Can anyone understand this?


CASH FLOWS



DISCOUNT RATES



This reflects the cost of capital for the organisation if gthe result is positive.

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