To a layman, the net investment gain is $100 ($1,100 - $1,000). Using NPV, the amount is smaller. This is because we take into account what our $1,000 initial amount would have earned us if we put it in the bank. Assuming that the interest rate is 5%, our $1,000 would have earned us $1,050. Therefore the net investment gained would have been $50 ($1,100 - $1,050). That’s not all. The amount is what we gained in one year’s time. But in today’s time, that $50 would have worth less today. That means if we put less than $50 into the bank, we would have gotten that $50 in one year’s time. The exact amount is $47.62($50 / 105%). This amount is the Net Present Value of our cash out flow of $1,000 (denoted by a negative sign) and a cash inflow of $1,100 in one year’s time (denoted by a positive sign).

Sounds complicated? Here’s another way of looking at it. That $1,100 in one year would have a present value of $1,047.62 ($1,100 / 105%). Since we took out $1,000 to gain that $1,100 (which has a present value of $1,047.62), the NPV is $47.62.

After you have understood the concept, you would not have to subject yourself to this kind of calculation. You can use a time line to present the above concept and an Excel Formula to calculate the Net Present Value.

Jason Khoo is the author of the website Advanced Excel Profit Centre. He hopes to share with his visitors how to simplify complicated calculations through the use of Excel. He also develop templates such as the NPV template, IRR templateto help users gain a better understanding of these concepts and make it more convenient for users to derive the values. He has also developed a business solution that helps budget planners consolidate budgets in SUPER quick time. The solution is also very useful for personal budgeting and analysis.