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Discussion in 'Growing and Managing a Business' started by bjn, Aug 19, 2010.
When figuring NPV for a prospective investment, does the formula require net income or gross income?
If you're talking "gross-" or "net-income" in an accounting sense, use whichever one is most closely aligned with cash flow. Better still, just use cash flow.
For an NPV calc to deliver meaningful results, the input data must be the amounts and the timing of the individual cash flows generated and/or consumed by the project or asset.
More directly to the point of your question, you could use either. Suppose, for example, I'm looking at an investment that is expected to generate a revenue amount R, but will cost me two expense amounts, E1 and E2. These are the only three cash flows involved, and they occur simultaneously.
I could either determine the PV of the net income N where N = R - E1 - E2, or I could separately calc the PV of each of those three elements, and add these three PVs together. Same answer either way, but in some cases the latter "component-by-component" approach will yield more useful insights.
A positive NPV would give you a better return. NPV is computed on the basis of the cash flow that accounts into the series of cash paid or received in today’s value. You can easily determine the NPV value by calculating the cash-flow received in the yearly terms with the discount rate. NPV = CF0 + CF1/(1+r) + CF2/(1+r)2 + CF3/(1+r)3 +...
Even a small change in the discount rate would highly affect the NPV value.