 Net present value is one of two capital budgeting analysis techniques to consider the time value of money in its calculations. The other is the internal rate of return. Recall that the payback period technique does not consider the time value of money, and that is one of the weaknesses of that method. Key characteristics of this method include that cash inflows and outflows are discounted at their present value and netted together to arrive at net present value. Projects with zero or greater net present value are acceptable. The discount rate is used in net present value calculations. Capital projects are financed with either debt or equity or a combination of both. These financing options have costs, and we are going to call these costs the discount rate. Although the slide shows a few other names, including the most technically accurate name, the weighted average cost of capital or WACC. When net present value is less than zero, it means that the project return, which we will later call the internal rate of return, or IRR for short, is less than the discount rate. When net present value is equal to zero, it means that the IRR equals the discount rate. And when net present value is greater than zero, it means that the IRR is greater than the discount rate. Since net present value is based on discounted net cash inflows and outflows, a change in the discount rate impacts net present value. A decrease in the discount rate increases net present value, and an increase in the discount rate decreases net present value. When I solve net present value assignments, I usually set up a table like this. Under the item column, I can enter the items that create cash inflows and outflows. The other columns group the cash flows in the period they occur. They can be netted together, and then I can apply the present value factors from the table, or I can use Excel to solve for net present value. Let's look at an example, and then I'm going to show you three ways to solve it. Adamant is considering the purchase of a $25,000 machine that would reduce operating costs by $7,000 per year. At the end of the machine's five-year useful life, it will have a $5,000 scrap value. The discount rate is 12%. So you can see I listed the items on the table, and when their related cash flows occur. I also made sure I noted which were cash inflows, like the savings and operating costs and the salvage value, and which were cash outflows, like the initial costs of the machine. Since there are cash flows in each of the periods one through five, I'm going to use the present value of a dollar factor for periods one through five at 12%, which is the discount rate. You can see where those factors have been entered into the template. Also note that the present value factor today, or now, is always one. The present value of a dollar today is always a dollar. So I multiply the total net cash flows by the present value factors to get the present value of cash flows. Then I sum them to get net present value of $3,070. Since it is positive, I can accept this project and know that the IRR of this project is greater than 12%. I could have also calculated the present value of the cash flows using Excel. You can see the present value of each of the cash flows. When I net them together, I get net present value of $3,071. The difference from the tables is the rounding of the factors in the tables. Finally, I listed on the slide the Excel present value formula used to calculate the present value of the cash flows. You may want to pause the video and write those down. The final way to show you how to solve this problem is using just one Excel present value formula. Since the $7,000 of annual operating cost savings is a reoccurring amount, like a payment, and the $5,000 of salvage value is a one-time amount in the future, like future value, I can use the present value formula we've already learned. So I set up the table like this. The initial cash outflow is already at its present value. So I only need to solve for the present value of the cash inflows and then net them together. I enter equals PV, open parentheses, 12%, comma, 5, comma, minus 7,000, comma, minus 5,000, closed parentheses. And that gives me net present value of $30,071. Our decision guidelines for net present value are investments with net present values greater than or equal to zero are acceptable, all things being equal.