Agriculture Reference
In-Depth Information
Net Cash Flow Before
Depreciation (dollars)
Depreciation
(dollars)
1
70,000
15,625
2
70,000
15,625
3
70,000
15,625
4
70,000
15,625
5
70,000
15,625
.
.
.
.
.
.
.
.
.
20
70,000
15,625
Total
1,400,000
312,500
Average
70,000
15,625
Average Investment
$
$
312, 500 ÷
312, 500
156 250
=
=
,
,
Av
eNet Cash Flow
Average Depreciation
erag
e
Simple Rateof Return
−
=
AverageInvestment
$70,,
625
$,
000
−
35
%
=
=
$,
250
simple rate of return. At the same time, a much larger project may have a lower simple rate
of return, but generate far more dollars for the agribusiness.
Net present value
Net present value (NPV)
is the current, net value of an investment, taking the time value of
money into consideration when evaluating costs and returns. As discussed earlier, the time
value of money captures the fact that a dollar received now is worth more than a dollar
received at some future date. In essence, net present value provides a measurement of the net
value of a multi-year investment in today's dollars. The net present value method uses the
discounting formula discussed previously to value the projected cash fl ows for each invest-
ment alternative. The net present value model is set up as presented below:
P
V
P
P
1
2
P
P
V
NPV
INV
+
+
++
+
=
2
(1
N
N
…
1i
(1
i
)
i)
(
1i
+
)
+
+
Where:
NPVn
e
et present value of the investment alternativ
INV ntial investment
i
net cash flows attributed to the investment
Pi
=
V erminal or salvage value of the investment
N ength of the planning horizon
V
Nt
t
i nterest rate or required rate of return, also called the cost of captial or discount rat
e
