ExcelNPV Error Correction

Calculating Net Present Value (NPV) in Microsoft Excel:

This area explains how to perform NPV calculations in MS Excel using a simple example. First, I must point out that even though the function in Excel that we will be using is called NPV, it does NOT calculate a true Net Present Value as we have in class. We will discuss what the NPV function in Excel really calculates and how to modify this result to get a "true" NPV.

Setup:

First, let's begin by looking at the following data:

Assume that the discount rate is 10%. You should recall that the formula for Net Present Value is:

NPV = Present Value of Cash Inflows - Present Value of Cash Outflows

Since the above cash flows are an annuity, you can quickly calculate that the Present Value of the Cash Inflows is $124.34 using your calculator. (N=3, I=10, PV=?, PMT=50, FV=0) Since there is only one cash outflow and it is at time zero, the Present Value of the cash outflows is $100. Therefore, the NPV should be:

Eq. 1 NPV = $124.34 - $100 = $24.34

Using the NPV function on your financial calculator, you would enter Cash Flow 0 (Cf0) as "-100," Cash Flow 1 (Cf1) as "50," Cash Flow 2 (Cf2) as "50," and Cash Flow 3 (Cf3) as "50." You would enter the interest rate as "10" and then you would solve for the NPV. You would also get $24.34 as the answer.

Microsoft Excel Procedures:

Now, lets examine the steps necessary to accomplish this in Excel. First, open a new spreadsheet and retype the information in the above table. Once you have entered the data, you are ready to enter the interest rate and

Time Cash Flow0 -1001 502 503 50

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begin to enter the formula for Net Present Value (NPV) as I have done below in Exhibit 1.

Make sure that you enter the discount rate as "0.10" and format it as percent for easier viewing. If you enter the number as "10" as you normally would in your financial calculator, Excel will NOT give you the correct answer.

Next, you will enter the Excel function for NPV. First, move your cursor to a blank cell (I am using cell E4) and select Insert from the menu bar. Then choose Function from the drop down list. This is illustrated below in Exhibit 2.



This process opens a dialog box. In the dialog box, you will select Financial in the left pane (under Function category) and scroll down to NPV in the right pane (under Function name). This is shown in the following Exhibit 3.



After you have completed this exactly as shown above, click OK. This will bring up a dialog box in the upper left corner of your screen. This box has been moved to the bottom in Exhibit 4 so we can see both the spreadsheet and the dialog box.

In the dialog box, you will first enter the cell location for the discount rate. You may do this by entering the cell reference, in this case E3, or you may simply click on the cell containing the discount rate. Then, you will click



on the box that says "Value1" or simply press the Tab key to move to "Value1" box. Enter the cell location that contains the FIRST cash flow. This is B4 in our example. Continue pressing Tab and entering the cell reference for all cash flows. You should then have a dialog box completed as in Exhibit 4 below.



After you have finished and your screen looks like the one above, click OK. This will enter the function into cell E4 and give you a value of "$124.34". Unfortunately, this is not the same as the NPV that we calculated earlier, which was $24.34. What has caused the difference?

The function in Excel is as follows: =NPV(rate, value1, value2,....,value29). You will notice that there is no provision in the Excel function for the cost of the project (the initial cash flow) at time zero. You will also notice that the answer that we calculated using the Excel function is exactly $100 higher than the answer we calculated manually. This difference is exactly equal to the Initial Outlay in our example project, $100.

The Excel function ignores the cash flow at time zero and is really just the PV of the cash flows, or the first part of the NPV given in equation 1 above. This is why the function gave you a different answer from the one you calculated manually.

The correction for the error in the Excel function is very simple. We simply need to subtract the cost of the project from the answer calculated for NPV. In this example the cost is $100, but if your problem has several cash outflows, then you would simply subtract the Present Value of the outflows from the value from the NPV function.

This is a very simple process. First, move your cursor to the cell containing the NPV function. In this example, it is cell E4. Then, you should press the "F2" key to edit the contents of the cell. Remember, your goal is to adjust the results from the NPV function to include the cost of the project (Cf0). Since the cost of the project in this example is entered as "-$100" we should add this to the value in cell E4. We should change the formula in cell E4 from "=NPV(E3,B4,B5,B6) " to "=NPV(E3,B4,B5,B6)+B3". The view immediately before the change is shown in Exhibit 5 below.



Once you have finished modifying the formula, press Enter. You will notice that the value in the cell is $24.34 now instead of $124.34. This is shown in the following exhibit, Exhibit 6.



Congratulations, thats it! You have successfully modified the Excel function to give a "true" NPV. Don't forget that you will have to correct the NPV function in Excel anytime that you are calculating the Net Present Value.

Copyright 1999, Mark A. Lane, Ph.D.



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ExcelNPV Error Correction