Perhaps the easiest way to explain this is to focus

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Unformatted text preview: PV) is a measure of the present value of future cash. To calculate NPV you discount future money at some assumed discount rate. In the following illustration you can see two sample investments, both with the same NPV, although very different cash flows. Both are discounted at 10% for calculating NPV. CALCULATING NET PRESENT VALUE (NPV) You can calculate NPV in a spreadsheet. Most spreadsheets have an NPV function (this one from Business Plan Pro®). In the illustration, the selected cell has an automatic function for calculating NPV based on defined discount rate and cash flows. Both of the investments have NPV of $766, even though one pays regular annual payments of $750, and the other pays nothing until a large payment at the end. Notice how the time value of money changes. The total payout of the first investment is less than that of the second, but because the first one’s payout starts sooner, they both have equal NPV. For more background on how the discounting calculation can be done manually, you should consult a finance textbook or search the Web for the term “net present value.” The best option is to build an NPV analysis into an Investment Analysis prepared especially for the investors. CHAPTER 22: GETTING FINANCED 22.9 Calculate Investors’ Internal Rate of Return (IRR) The Internal Rate of Return (IRR) is based on the NPV calculation. It is the discount rate at which the NPV is zero. Most spreadsheets have functions that help you calculate IRR from a cash flow. AN INTERNAL RATE OF RETURN (IRR) CALCULATION You can see how the investment that pays sooner has a higher IRR, even though the second investment pays more. One important point with IRR, as the two investments show, is that although they have equal NPV, they have very different IRRs. That’s because the better one generates cash flow sooner. Another important IRR point is that venture capitalists expect very high IRR on new investments. In recent years venture capital funds have generated overall Rates of Return of 50-100% or better, meaning that the winning deals...
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This note was uploaded on 01/26/2014 for the course BUINESS 102 taught by Professor Unknown during the Winter '09 term at University of Phoenix.

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