632598256894

Similarly, the year 2 cash flow was forecast to be $2.42 million also. The present value of that
second-year cash flow is only $1,680,556:
The longer the time over which a cash flow is discounted, the lower is its present value. Exhibit 6.4
presents the forecasted cash flows and their discounted present values for the brewery project.
Exhibit 6.4 Discounted cash flows for brewery project (thousands).
Summing the Discounted Cash Flows to Arrive at NPV
Finally, we can calculate the NPV. The NPV is the sum of all discounted cash flows, which in the
brewery example equals $614,000. To understand precisely what this means, observe that the sum of
the discounted cash flows from years 1 through 10 is $10,614,000. This means that the project
generates future cash flows that are worth $10,614,000 today. The initial cost of the project is $10
million today. Thus, the project is worth $10,614,000 but costs only $10 million and therefore creates
$614,000 of new wealth. The managers of the beer company would be well advised to adopt this
project because it has a positive NPV and therefore creates wealth.
More NPV Examples
Consider two alternative projects, A and B. They both cost $1 million to set up. Project A returns
$800,000 per year for two years starting one year after setup. Project B also returns $800,000 per year
for two years, but the cash flows begin two years after setup. The firm uses a discount rate of 20%.
Which is the better project, A or B?