Now, we have learned theory of present value and net present value, or also known as NPB.
Now, again, we have to help John to evaluate two investment opportunities.
So option one for John is to invest ten thousand dollars in buying a car and then he will receive two
thousand dollars for the next five years by lending his car to a car rental company at the end of five
years.
He can sell that used car for four thousand dollars for additional income.
Now, option two is to loan 10000 dollars to his trustworthy friend, for which he will be getting 500
dollars each year for the first two years, then two thousand dollars per year for the next two years.
And then for the next three years, he will be getting another three thousand dollars per year.
Now, our objective is to help John in identifying which option is better for him.
He can also invest this money in a savings bank account for an interest rate of six percent per annum.
So to help John, we have to find present values for both of these options.
Now, there are several informations hidden in this problem that we can extract.
So first is the amount or the P value is 10000.
The odd.
Or discount rate is six percent because the bank is giving a six percent per annum.
For the option one, the salvage value is 4000.
That means after the completion of five years, he will be getting another four thousand dollars for
selling the car.
And option B, this salvage value is zero.
Since he will not be getting any additional money after completing the term.
Now, I have also listed the payment term for both of these options, so for option one, there are
two columns for years and return.
So at the end of year one, he will be getting two thousand dollars at the end of year two.
He will be getting another two thousand dollars and so on, Bill.
Five years.
And I have also listed value, which is the salvage value at the end of year.
No, for option B, the value is zero and this option will give return for the next seven years.
So I have listed years in this column and the return he will be getting in this column.
Now we will use Excel to find the present values for both of these options.
Now there are two ways to find the present value.
First one.
As the Formula Peevey and second one is the Formula NPB.
We use Peevey when they return each year is consent.
So, for example, an option one, we are getting two thousand dollars for each year.
So here we can use Peevey, we can use NPV when the returns are not concern throughout Dotun.
So for the first two years, we are getting 500.
For the next two years, we are getting 2000 thousand and then three thousand for the rest of three
years.
So the return is not constant.
So here in such case, we can use NPB.
Now, let's first calculate the present value for option one will be using B.V..
Formula, and if you want any help regarding any of these parameters that this function is taking,
you can go to formula tab.
And click on this insert function button.
When you click it, it will give you a dialog box in which all the parameters are mentioned, and if
you select any parameter, it will give you the definition of that parameter just below in the dialog
box.
So first parameter here is rate, so what rate is zero point zero six?
The second parameter is number of dumps.
In this case, we are getting two thousand dollars for five years, so our term is five, so we will
select.
This cell.
Now, the next parameter is payment, we will be getting each.
So in this case, we are getting 2000, so we will be selecting this cell.
The next is.
This is the salvage value that we will be getting at the end of the term.
So at the end of term, we will be getting another four thousand dollars when John sells his car.
So we are selecting 4000 here.
The next is type.
So zero is for end of year and one is for the beginning of the year, we are considering we are getting
all the payment at the end of the year.
So we will write settle.
And now you can see that we can preview the result of this formula in this dialog box itself.
So now we can click on OK?
And you can see that we have a total.
Now, one more thing to notice is that this total is a negative value.
There is no particular reason why this is negative.
This is just one of the feature or one of the thing of Ms.
Excel, it will always show you present value with the opposite sign.
So if you are getting money and if you want to calculate the present value, it will always show you
present value with the opposite sign.
So if you are losing money, it will show you positive.
And if you are gaining money, it will show you negative.
So my advice is that I always look at your returns.
If the returns are positive, change the sign of the total present value.
So I will just put negative in front of this no, you can see that we are getting a positive value,
so always look at your returns and take the same accordingly.
Or you can also remember that whenever you are using a free use, negative sign before the formula.
Now, this is the present value for option A. We are investing ten thousand dollars and we are getting
around eleven thousand four hundred dollars back, so this is a good investment for John.
Now, let's calculate the present value for option two here, we cannot use fee because the returns
are not constant.
For that reason, we have to use NPV.
The formula of NPV is equal to NPV.
And then first we have to give the rate.
It is 01 06, and then we have to give the values.
So these are all the values that we have.
So this is the present value of option second.
One more thing is that here, John is getting money, that's why we are using positive number for all
the return value.
But suppose if John have to invest another three thousand dollars at the end of five years, then we
can put minus Simbel as well for investments or for the amount that John is paying.
So you can use both signs, positive and negative, to represent inflow and outflow of cash.
So the total and maybe an option two is around ten thousand five hundred.
So we can directly compare the present value of option A and option B to suggest which one is better.
And since the present value of option A.
Is more than the present value of option B, we can suggest to John to buy a car and give it to a car
rental company.
So that's all for this lecture we have discussed two formulas, B.V. and NPV PV is used when the cash
inflow is constrained and NPV is used when the cash inflow or outflow is not constant.
Again, remember to use negative symbol when you are using baby formula.