Archive for May, 2007

# Reader question: calculating a basic NPV problem

### Corporate finance, MBA topics

My philosophy on maintaining this blog site is very different from that of most bloggers. Rather than update it constantly with the latest happenings, I aim to write longer how-to explanations and tutorials that are less time-sensitive and provide useful reference material long after they’re written.

Though my posting rate has declined dramatically recently (this will improve soon), I still receive questions from readers, mainly about using Excel functions. Last week, I received one from a reader named Jae, who asked a Finance 101 question:

I have a problem in my finance class where the annual revenues from a project is \$500,000 and annual costs are \$300,000. The corporate tax rate is 40% and the cost of capital is 12%. How do I calculate NPV of the project?

The original problem has probably been paraphrased, and lacking other information, here’s how I’d interpret the problem. The project generates pre-tax revenues of \$500K a year, and incurs operating costs of \$300K a year. The corporate tax rate is 40%, the cost of capital is 12%, but nothing is provided about how long the project will last. For simplicity’s sake, let’s suppose it lasts 5 years and then ends at the end of year 5.

The setup for solving this problem is very similar to another post I wrote on a while back.

Here’s how I’d set up the calculation in Excel to solve this problem, assuming the project lasted 5 years: