Why is Net Present Value NPV useful?
NPV is the foundation of the discounted cash flow (DCF) process. With NPV you enter a discount rate which is the yield you would like to get. The NPV is the amount you need to adjust the beginning amount (ie purchase) by to equal that yield. The nature of the NPV is that it takes everything into account that made up the cash flow. The only weakness is that it is hard to calculate (not with planEASe of course), and that it uses all the assumption values (so, in turn, you are required to enter these assumptions, which means more work on your part).
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Why is Net Present Value NPV
useful for commercial real estate?
NPV is the foundation of the discounted cash flow (DCF) process. With NPV you
enter a discount rate which is the yield you would like to get. The NPV is the amount
you need to adjust the beginning amount (ie purchase) by to equal that yield. The
nature of the NPV is that it takes everything into account that made up the cash flow.
The only weakness is that it is hard to calculate (not with planEASe of course), and
that it uses all the assumption values (so, in turn, you are required to enter these
assumptions, which means more work on your part).
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Net Present Value NPV Considers:
Considers / Ignores
• Considers: All assumptions entered such as: Scheduled Income, Purchase
Price, Down Payment, Current Debt Payment, Vacancies, Expenses,
Property Taxes, Lease terms, Revenue Growth, Rent Control, Expense
Growth, Property Tax Growth, Deferred Maintenance, Debt Amount
(Ratio), Interest Rate, Interest Rate Changes, Payment Changes, Points,
Prepayment Penalties, Depreciation, Capital Expenditures, Income Taxes,
$25,000 Exemption, Passive Losses, Appreciation, Capital Gains Tax ... and
all other entered assumptions
• Ignores: Only assumptions not entered
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In the world of commercial real estate, cash flows occur monthly and the dollar amounts of the
revenue and expense cash flows are almost always irregular. In the past there were mathematical
games that were played to get the Net Present Value to reflect the monthly irregular cash flow, and you
might still hear some of the old ways spoken of today, like "beginning or end of period" or "mid year
convention" (Monthly vs Yearly IRR Discounted Cash Flow Measure Comparison). These tricks were
necessary in a world where you typed individual cash flows into a calculator or spreadsheet. However,
in the modern computing world there is no need for these mathematical tricks, because computers are
now fast enough to handle the present value discounting process on a monthly basis. The initial
process for computing NPV in Excel and other spreadsheets made the assumption that the cash flows
occurred annually and at the end of the year. With the new speed of computers, it became feasible to
compute NPV more accurately by including the date of the cash flow as well as the amount. This new
(and much more accurate) method of computation is known within Excel (and other spreadsheets) as
the XNPV function. Here are links to descriptions of the XNPV process:
• Excel XNPV Description
• Google Spreadsheet XNPV Description
Monthly Calculations
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If you are interested how to verify the monthly NPV look to this page
Verify Monthly IRR and NPV Using Excel or Google Spreadsheets
XIRR and XNPV. Also there is a "Net Present Value Report" shown at
the end of this article that has all the monthly information to use for the
verification. The NPV's shown in the proforma examples will be very
slightly different than the true XNPV process show in the planEASe
Cash Flow Utility, Excel XNPV, and Google Spreadsheet XNPV because
the NPV's shown in the Proforma Samples do not use leap years, so in a
six years analysis there can be 1 or 2 days difference in time length.
XNPV Verification
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A major difficulty with using Net Present Values in order to make
investment decisions is determining what discount rate to use in the
calculations. Theoretically, the proper discount rate is the rate at which
alternative investments may be made. Thus, if a savings account is the
investor’s alternative, the six percent discount rate currently offered by
the bank may be appropriate. Other investors may feel that they have
different alternatives, however. For this reason, the individual investor’s
discount rate is an assumption in the analysis so that it may be varied for
each investor. This difficulty in determining the proper discount rate is
eliminated, however, when the investor uses the Internal Rate of Return
to evaluate the investment.
Determining what Discount Rate to use
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Net Present Value NPV Example
2010 2011 2012 2013 2014 2015
IRR Before Debt 1.5% 9.0% 9.9% 9.0% 9.5% 8.0%
IRR Before Tax 9.2% 12.1% 9.5% 11.0% 7.0%
IRR After Tax 6.5% 8.8% 6.6% 7.8% 4.6%
NPV Before Debt @10.00% ($246,299) ($54,097) ($8,769) ($106,089) ($66,107) ($273,216)
NPV Before Tax @10.00% ($236,599) ($16,136) $56,761 ($17,540) $42,716 ($146,603)
NPV After Tax @10.00% ($233,929) ($68,875) ($32,053) ($121,655) ($95,859) ($265,158
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Try out this ratio yourself !!!
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