Hi guys, welcome to the super easiest video on net present value calculation.
You will be shocked, remember you can always go back to my website for more free videos.
Alright if I go too fast in this video no problem.
Just watch my slower video by following the instructions down here.Alright, so I'd like
to start with the word net.
What do we mean by net?
Well it's usually the result of different amounts combined.Let's say you are at an expensive
restaurant and the food is $100, but you have a $15 discount, then we can say that the cost
is or the price is $85 net.
Okay, so now how do we apply that to business? Well let's say that you gave your friend $100 today
under the agreement that you will get back $105 next year.
So I write this down as negative because you're paying it, and this is positive because you
are receiving it.
So in this case you have a net value.
A simple net value of $5.
Where do we get the $5?
Well $105 less $100 is $5.
Does this look like a good deal to you?
I think it looks like, it seems like a great deal because you give a $100 you get back
a $105 you gain $5, however this is only the net value.
It is not yet the net present value.
Present means today and when we think about the net present value because present means
today, we have to think about the time value of money and interest rates in the market
right now.
So let's just pretend that interest rates right now given by the bank or any other risk
free place, like the government.
Interest rates are at 6%.
So what does time value of money mean?
It means that $1 today is worth more than $1 given to you tomorrow.
And isn't that true, wouldn't you prefer that I give you $1 today instead of promising to
give you $1 tomorrow?
Even if my promise was good you'd prefer to have the $1 given to you today.
Why?
Well because, for example $100 or $1 whatever, let's just say $100 put in the bank today
at a 6% interest will be worth $106 next year.
That's the same as saying if bank interest is at 6% then $106 given next year is the
same as only $100 given today.
You see?
So then now that we know that, how do we get the net present value?
Well, it's very simple.
The first step is this, boom!
What is this?
What are these scary numbers over here?
Well if you don't already know, this is the simple present value formula.
The simple present value formula.
And what makes it different from the net present value formula over here?
Net, this one is simple.
Well this for one number okay.
Instead of a combination of numbers.
When we say net present value, we're talking about a combination, remember.
So that's the difference between simple and net.
So where do these numbers come from?
Well very simple.
This $105 comes from here.
This .06 represents the interest rate over here.
And the negative one over here represents this one year over here, as simple as that.
Now, first important question, why is it .06, okay why not .6?
Well remember in percentages 6% is written as .06 okay.
If you wrote.6 here that would be 60% and not 6%.
Why is it a negative one over here for this one year later?
Well, remember were trying to get the present value or the net present value of these 2
amounts today.
So in this present value formula over here, we're trying to get the value of $105 given
next year, but we want to know the value of this $105 today, one year earlier.
So, to represent the fact that we're bringing this $105 backward by one year, we put a negative
one.
It is negative because we go backwards.
Okay, and very important.
In your textbook or with your professor you might not see the present value formula looking
like this.
It might look something like this instead.
That's the long way.
This is a traditional way because if your calculator sucks and you don't have a scientific
calculator then you cannot do the negative one (-1) and you have to put a positive one
(+1), but if you put a (+1) then you have to bring this stuff under the $105 and make
it look like this.
I do not recommend this.
It's more confusing if you ask me.
So I suggest you just buy a good calculator.
Alright so back to our formula.
Are we done yet in the formula?
No, remember net present value.
Net is a combination of these two.
So now, we also have to do boom!
This, so what is this?
First of all I'll explain later.
If you want, you can delete this.
I might as well explain it now.
If you want, you can delete this and the value will still be negative (-$100).
So don't be surprised if your textbook just has the $100 over here, but there's nothing
over here because you can delete this if you want, but personally I do not like to delete
it, why, I like to keep it consistent with this over here to avoid confusion.
Okay, after you're already used to all these formulas then go ahead and delete it.
So let's continue.
Now where does this negative (-100) come from?
Again comes from this.
Where does this .06 come from?
Comes from the 6%.
Where does this -0 come from.
Where does this (-0) comes from?
Remember, in this case over here we had a negative one (-1) because we wanted to know
the $105.
The value of the $105 one year backward, one year earlier.
However, in this case.
This negative 100.
In this case this negative 100 (-100) you are paying today.
So you're bringing it back by 0 years, by 0 years, so that's why I have a negative zero
(-0) over there, but like I said you can delete that if you want.
You can delete this whole thing if you wish and the value will still be the same at negative
one hundred (-100), but I prefer to keep it so that it's consistent and not confusing.
Alright, so now using our scientific calculator.
Okay, we get this, boom!
$105 multiplied by 1.06 raised to the (-1) we get 99.06.
What does this mean?
This simply means that 99.06 is the present value of $105.
If we take interest rate into account then $105 given next year is the same as $99.06
given this year.
Next step let's simplify this, simplify this, boom!
There we go.
You see that, so this is what I mean by you can delete the 1.06 if you want because as
you can see when we simplify this whole thing, it comes out the same as this.
Alright so there we have it.
We now have our net present value formula.
So if we simplify it further using our scientific calculator, we get, what, we get boom!
Negative 94 cents.
See as you can see this negative 94 cents is a lot less, sorry net present value is
negative ninety four cents, which is a lot less than the simple net value of $5.
So what does this mean?
What this means is that in simple numbers, we gain $5, but in present value dollars,
meaning we take the value of this money today then we lose 94 cents if compared to what
you would have gotten if you deposited your money in the bank instead.
To simplify it further in a case like this if your net present value is positive, you
win.
If it's negative you lose.
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