Net present value is the same calculation as your present value, but it's net of an original cost. For example, let's suppose that a restaurant company pays $1.2 million for a franchise that it hopes it can sell for $3 million in five years. What is the present value of this transaction? So there is a negative cost upfront right? It's minus $1.2 million. But the benefit is that they're going to receive $3 million in five years. Suppose, for this example, the discount rate is 8%. Then the present value, the net present value of this particular transaction is $841,750. Our NPV, we use that same present value calculation by looking at the discounted future cash payments, but it's net of your upfront costs. All right, we're going to go to the Excel where we're going to actually look at NPV right here. Okay, this is NPV in Excel that goes along with NPV examples. So here we have our NPV work book in our Excel. And I'm going to set this up so that we can actually look at a transaction. The transaction will be negative costs upfront and then cash flows in the future and then this workbook will help us determine whether or not this investment is a good decision. So we're going to set this thing up so that I'm talking at 5% interest. Suppose that I have to pay $100,000 To purchase the rights to a sign. So, I'd buy a sign on the side of the road, and I'd pay $100,000 for that sign. Now, what's going to happen is, going forward, I'm going to receive rent from that sign. People are going to pay me to put their advertisements up on that sign. Now, let's suppose that my sign has a 5-year useful life, so, I pay $100,000 for this sign. Now, let's suppose that my stream of rent is $20,000 every year. So on its face, this looks like it's just a wash. You pay a $100,000, you're going to get $100,000 back. I get $20,000 each year right? $20,000 use for the life of five years, it's $100,000. I pay $100,000, I get 100,000, except, the 100,000 that I'm receiving is not all at once. It's spread out over five years. So, at 5% interest rate, my discount factor for the first year is 95%. That is, each $1 is really only worth $0.95. Each $100 is really only worth $95. So, $20,000 after year one is only worth $19,000 in change. My present value factor, my discount factor for year two is 91% so each dollar is only worth $0.91. So my $20,000 I receive in year two is only worth $18,000 in change. And then in year 3, it discounted at 86% so each dollar is only worth $0.86. So now my $20,000 is only worth 17 and change and then year four, then year five. So what happens is that the accumulation of the value of these future Payments is not even worth 100,000. As a matter of fact, the cumulative present value of this scenario is negative $13,410. So if I pay $100,000 today and receive these equal payments of $20,000 over the next five years, this investment really has a negative value. Supposed the signage, however, generates $25,000 a year instead of $20,000 a year. So given these amounts, after year one, my $25,000 is worth $23,000. After year two, it's worth $22,000. After year three, it's worth $21,000, then $20,000 then $19,000. The cumulative present value of this net income stream, that is the positive stream net of my initial cash outlay, is a positive $8,237. How could I use a calculation like this? I could look at two separate investment possibilities and identify the investment possibility that gives me the higher net present value. Let's set this up and let's look at this example briefly.
