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# Discounted cash flows and net present value

### Discounted cash flows (DCF) We estimate how much we will spend or make for a number of periods in the future, a series of cash flow we estimate for an action plan.

What is the rate of growth or decline - the internal rate of return (IRR)? Using Excel's IRR function for the example, 10.6% is the internal rate of return that explains this flow of funds.

### Net Present Value (NPV)

A better question to ask is: will the cash flows return more than making the same investment of \$44.70 in another opportunity with a known rate of return, for example, for an AAA corporate bond at 10.0%? When you use Excel to calculate NPV, you provide that discount rate. The Excel setup with a 10% discount rate and five years of cash flows is:

0.5 = NPV(10%, -44.7, 16.0, 14.7, 13.9, 11.9)

### Making judgments using NPV

The NPV of 0.5 is positive, so it is better to invest in the project. That makes sense; the IRR in the example for discounted cash flows above was 10.6%, slightly better than the threshold discount rate 10% we used in the NPV calculation. If NPV were zero, it would be the same as the alternative investment. If the NPV is less than zero, it would be worse.

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