Cookie and Privacy Settings

This website uses cookies to enable essential functions like the user login and sessions. We also use cookies and third-party tools to improve your surfing experience on preplounge.com. You can choose to activate only essential cookies or all cookies. You can always change your preference in the cookie and privacy settings. This link can also be found in the footer of the site. If you need more information, please visit our privacy policy.

Data processing in the USA: By clicking on "I accept", you also consent, in accordance with article 49 paragraph 1 sentence 1 lit. GDPR, to your data being processed in the USA (by Google LLC, Facebook Inc., LinkedIn Inc., Stripe, Paypal).

Manage settings individually I accept
expert
Expert with best answer

Francesco

100% Recommendation Rate

3,414 Meetings

15,746 Q&A Upvotes

USD 449 / Coaching

6

Why is NPV calculated as profit/discount rate

In this case, the NPV is calculated as profit/(discount rate-growth rate)-investment. Isn't NPV=FV/(1+i)^n?

In this case, the NPV is calculated as profit/(discount rate-growth rate)-investment. Isn't NPV=FV/(1+i)^n?

6 answers

  • Upvotes
  • Date ascending
  • Date descending
Best Answer
Book a coaching with Francesco

100% Recommendation Rate

3,414 Meetings

15,746 Q&A Upvotes

USD 449 / Coaching

Hi there,

The value generated by an asset in perpetuity can be calculated with the perpetuity formula as follows:

V=FCF/(r-g)

Where

V = Value of the asset

FCF = Free cash flow

r= Discount rate

g= Growth rate of FCF

Usually g=0 and FCF is approximated with profits for simplicity. If you want to calculate the NPV, you can then subtract the initial investment.

The previous formula for the value of an asset in perpetuity is equivalent to the following:

Using the perpetuity formula allows you to calculate the value faster – which is why is normally used in case interviews instead of the second formula.

For a more technical explanation, you can look at the following link:

https://www.preplounge.com/en/consulting-forum/case-net-present-value-calculations-325

Best,

Francesco

Hi there,

The value generated by an asset in perpetuity can be calculated with the perpetuity formula as follows:

V=FCF/(r-g)

Where

V = Value of the asset

FCF = Free cash flow

r= Discount rate

g= Growth rate of FCF

Usually g=0 and FCF is approximated with profits for simplicity. If you want to calculate the NPV, you can then subtract the initial investment.

The previous formula for the value of an asset in perpetuity is equivalent to the following:

Using the perpetuity formula allows you to calculate the value faster – which is why is normally used in case interviews instead of the second formula.

For a more technical explanation, you can look at the following link:

https://www.preplounge.com/en/consulting-forum/case-net-present-value-calculations-325

Best,

Francesco

For perpetuity (cash flows lasting forever), this formula is used: NPV = Profit/(discount rate-growth rate). The other formula is used when the time period is fixed.

For perpetuity (cash flows lasting forever), this formula is used: NPV = Profit/(discount rate-growth rate). The other formula is used when the time period is fixed.

Book a coaching with Ian

100% Recommendation Rate

267 Meetings

23,176 Q&A Upvotes

USD 289 / Coaching

Hi there,

I don't think the other coaches have really answered your question. You have 2 questions right?

1) You're asking why we subtract the investment?

Remember, NPV calculates today's value of future earnings. If we do NPV we get what all of our future profits are worth. Then, we need to subtract it from our upfront investment to make sure the NPV is larger than what we're paying today!

2) You're asking why we don't do "(1+i)^n"

Then, the reason we don't have "^n" is because that occurs when we have specific payouts in year 1, 2, etc. I.e. it does not go on forever. In the case above, we have cashflows into perpituity.

Hope this helps!

Hi there,

I don't think the other coaches have really answered your question. You have 2 questions right?

1) You're asking why we subtract the investment?

Remember, NPV calculates today's value of future earnings. If we do NPV we get what all of our future profits are worth. Then, we need to subtract it from our upfront investment to make sure the NPV is larger than what we're paying today!

2) You're asking why we don't do "(1+i)^n"

Then, the reason we don't have "^n" is because that occurs when we have specific payouts in year 1, 2, etc. I.e. it does not go on forever. In the case above, we have cashflows into perpituity.

Hope this helps!

Book a coaching with Clara

100% Recommendation Rate

58 Meetings

15,735 Q&A Upvotes

USD 229 / Coaching

Hello!

There are two ways to calculate NPVs:

  • When we know the timeframe, then the formula you mention, NPV=FV/(1+i)^n, applies
  • When we don´t and we are doing at perpetuity -meaning, all the cashflows annualized forever-, then we use the formula that is used in the problem

Hope it helps!

Cheers,

Clara

Hello!

There are two ways to calculate NPVs:

  • When we know the timeframe, then the formula you mention, NPV=FV/(1+i)^n, applies
  • When we don´t and we are doing at perpetuity -meaning, all the cashflows annualized forever-, then we use the formula that is used in the problem

Hope it helps!

Cheers,

Clara

Book a coaching with Antonello

98% Recommendation Rate

161 Meetings

5,826 Q&A Upvotes

USD 249 / Coaching

Book a coaching with Gaurav

100% Recommendation Rate

198 Meetings

6,592 Q&A Upvotes

USD 169 / Coaching

Hey there!

It's quite simple - the time frame is not fixed, so the formula which you mention cannot be applied. Be careful with such conditions while case solving, it can change the outcomes dramatically.

If you have any other questions - write to me,

GB

Hey there!

It's quite simple - the time frame is not fixed, so the formula which you mention cannot be applied. Be careful with such conditions while case solving, it can change the outcomes dramatically.

If you have any other questions - write to me,

GB