What is NPV ? Norair Yeretsian

As a measure of profitability as opposed to a determination of  worth ( value)
the NPV ( net present value ) is yet another good calculation you could ran
to better understand and test your consideration of income producing and
cash flow providing real estate.

This calculation is easily performed by your financial calculator ;
HP 10 BII. You could run the following cash flows :

for example : Cash Flows for End Of Year (s) starting with the initial
investment going in as a negative amount

and then populating the balance of the cash flows  as follows

Set :     1  p/yr       [ Shift  C ]  [ 1 shift p/yr ]

Initial Flow.EOY1 … EOY2 …… EOY3 ….. EOY4 …… EOY5

(804,000). 122,610 … 137,323 …153,802 ..172,258 .. (1,192,929)

CFj  ….          CFj      …    CFj  ……  CFj ………  CFj ……..  CFj ..

select and  enter an appropriate discount rate  say  10 %

10   [I / YR]

and now press  [ shift ]   [ NPV ]  : $ 394,877 positive NPV results !

[ as an aside the IRR ; be calculated : [shift  IRR/YR]

What just happened and what does it mean ?

NPV = net present value, a measure of profitability were an
appropriately selected discount rate is applied to all the cash flows
with the initial investment subtracted to arrive at a net amount.
The resulting netted present value of the cash flows to the initial
investment at the discount rate results in Positive/Negative or Neutral amount.

In the event this number  is positive (NPV) this reflects a surplus and tells
the investor , there is margin to possibly pay more / bid higher by this number
and still achieve the desired objective and yield !

The Buyer here could potentially pay up to an additional $394,877
and still achieve their desired objective(s).

If on the other hand the resulting number  is negative (NPV) this reflects a loss
in relation to the expectations of the investor. In the event the above number was
negative then you would reduce the amount you would be investing by this amount
to achieve the investor’s desired objective(s).

There is also the possibility theoretically for the resulting number to be zero
at the selected discount rate in which case the selected discount rate reflects ,
is equal to the IRR% rate .If this is what the investor wants then you have arrived!

Once you solve for the NPV, you could simply press [ shift]  [ IRR %] to arrive
at the internal rate of return for the investment, based upon the series of cash
flows discounted back year over year to the present and netted out against the
initial investment (equity ) .

Investment options can be ranked by their resulting NPV numbers. A positive
NPV indicates the extra ( margin) above the desired expectations of the investor.
And therefore in a bidding war for an income property.It can guide you, tells
the investor how much further he could possible go and still achieve the desired
objectives as established by the investor.

This is a nice tool to have and use , however one should use it with cautious optimism:
it does not tell you what the property is worth. And the calculated / subjective
determination of the discount rate to arrive at the NPV should be kept in
perspective by the investor. It does not address the assumptions made and the property
physical fundamentals and locational characteristics… much to think about
before a final decision is made to invest or not. Good luck .

It’s always good to use a professional and they are easy to find.

Let continue the discussion on twitter or below:

EnvoyCapRealty

nyeretsian@yahoo.com May 21, 2010