NPV with a positive initial cashflow

Paul Hunt

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Hi Mr Excel - new user.

In this project a property is being vested in a company (title transfer with out cost) thus no initial capital out lay.

Positive cash flow revenue commences immediately. In the third year of ownership there is an obligation to leverage the assets value i.e. take out a mortgage to purchase another property. Thus the first negative cash flow isn't until year 3 and stays negative for 23 years whilst the mortgaged amount is being amortised. Following that positive cash flow is received, technically in perpetuity, say 99 years.

Will excel accurate calculate NPV?

I hope this makes sense?

Kind regards
Paul.
 

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Sure. Mathematically, the NPV is just the sum of the discounted cash flows. And that is exactly what the Excel function calculates. It does not care about the sign of the cash flows.

It is the mathematical IRR that requires a mix of cash flow signs. The IRR is the discount rate that causes the NPV to be zero. That can happen only if at least one cash flow has the opposite sign.

That said, I'm not sure I agree with your assertion that there is "no initial capital outlay". Off-hand, I suspect you should consider the initial value of the property (appropriately signed) to be the "initial outlay". But to be honest, I am not giving this much thought.
 
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Will excel accurate calculate NPV?
Sure. Mathematically, the NPV is just the sum of the discounted cash flows. And that is exactly what the Excel function calculates. It does not care about the sign of the cash flows.

Although my comments about the NPV and IRR calculations were correct, I see that I made some incorrect assumptions about the nature of the cash flows in question. So I just want to add that my incorrect assumptions are irrelevant to my response, so far as it went.

However, even though you asked about the NPV, due to the nature of your concern, I wonder if you are really asking about the IRR, which is the discount rate that should cause the NPV to be zero.

Again, there is no requirement that the initial cash flow is negative. However, even the mathematical IRR struggles as the number of sign changes in the cash flow series increases. There might be more than one IRR. And the Excel (X)IRR function struggles even more, due to a flawed design, IMHO. You might need to rely on the "guess" parameter in order to get a correct result.

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Also, you asked about "accuracy".

The accuracy of the Excel NPV and (X)IRR functions are limited by the internal representation of numeric values, which is the industry-standard 64-bit binary floating-point. And the accuracy of any computer calculation, regardless of the internal representation, is limited by the relative magnitudes of the operands.

In your case, the magnitudes of the PV of the initial cash flows might be very large, whereas the magnitudes of the PV of the 90-year-old cash flows might relatively small.

The devil is in the details, which you do not provide. If you still have doubts, I suggest that you post some representative cash flow values (including the initial and ending values of the transferred property).

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That said, I'm not sure I agree with your assertion that there is "no initial capital outlay". Off-hand, I suspect you should consider the initial value of the property (appropriately signed) to be the "initial outlay". But to be honest, I am not giving this much thought.

I would like to reiterate this point with some analogies.

1. Suppose you simply sold the transferred property 20 years later, with no intermediate cash flows.

In calculating your ROI (or IRR), would you really accept any price for the property, since there was "no initial cash outlay"; thus any price is "all profit"? Would you accept a price that is half the initial value, for example?

I hope your reasonable answer is "no".

-----

2. Suppose you had invested $100,000 in a portfolio in 2010. Now, assuming today is 31 Dec 2017, you want to calculate the NPV for the period from 31 Dec 2014 (effectively the past 3 years).

Would you really not consider the value on 31 Dec 2014 because there was "no initial cash outlay" on that date?

Again, I hope your reasonablel answer is "no".

-----

In both cases and for all NPV and IRR cash flow models, we include the "imputed value" of assets on the starting and ending dates, as well as any actual cash flows.

The imputed value is the actual value, if there is a cash transfer (investment or liquidation). Otherwise, it is the market value at the time.

Use the appropriate sign for the imputed values, depending on your choice.
 
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Thanks joeu2004

Sure. Mathematically, the NPV is just the sum of the discounted cash flows. And that is exactly what the Excel function calculates. It does not care about the sign of the cash flows.

It is the mathematical IRR that requires a mix of cash flow signs. The IRR is the discount rate that causes the NPV to be zero. That can happen only if at least one cash flow has the opposite sign.

That said, I'm not sure I agree with your assertion that there is "no initial capital outlay". Off-hand, I suspect you should consider the initial value of the property (appropriately signed) to be the "initial outlay". But to be honest, I am not giving this much thought.
 
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