How to Calculate Net Present Value (NPV) and how to use it

by Manish Chauhan · 10 comments

In this post we will talk about How to think and calculate Net Present Value of a transaction involving Financial Payment , and why its important to understand the concept .

Consider the following Example :

You have to lend Rs 1,00,000 to one of your friends and He is offering you following choices .

Choice 1 : He will pay you Rs 18,000 per year for next 10 yrs .

Choice 2 : He will pay you 13,000 per year for next 15 yrs .

Choice 3 : He will pay you Rs 8,000 per year for whole life .

You have landed on the most read article of this blog For this month , Make sure you Get updates on Email or Join Our Facebook Page


Which one should you choose ?

Here you have to take a decision of choosing from one of the choices . The logical decision here will be to go for choice whose Net Present Value is Highest . You have to understand the time value of money . Rs 10,000 received today is much more valuable than Rs 10,000 received 10 yrs later, even Rs 15,000 received after 10 yrs .

So you have to see that which choice has the highest worth if you calculate its Value today .

So how do you calculate the Net Present Value in this case , where you have Rs X receivable every year for n years . Here you also have to consider present rate of returns which you can assume at 8% .

So We have 3 variables

X : Amount received per year

n : Number of years

r : Present rate of return

NPV = X * [(1+r)^n – 1]/[r * (1+r)^n]

Calculating through this formula , we get the NPV of the choices as

1. 120781

2. 111273

3. 100000

Net Present Value of the last choice is simple , how much money do you put in bank today that will fetch you 8,000 per year forever ? If X is the amount than at 8% interest you get 8,000 , so

8% of X = 8,000

.08 * X = 8,000

X = 8,000 * (1/.08)

X = 1,00,000

If you see the total amount received in all the cases you will realise that the choices with lesser NPV will give you have higher Total amount .

For Case 1 : NPV = 120781 , Total amount received = 1,80,000

For Case 2 : NPV = 111273 , Total amount received = 1,95,000

For Case 3 : NPV = 100000 , Total amount received = Infinite (The amount is paid forever)

Calculate NPV for your self , see this calculator

But you have to understand that “Total amount received” is not important . What can you do with the money is more important ? So the real Indicator is Net present Value of Money . You have to understand the Difference between Price Vs Value . Price is what you pay , Value is what you get . Value is important not Price .


Real Estate Case

If you go for a home which cost Rs 50 Lacs @9% Interest for 20 yrs . Your EMI will be around 45,000 per month .

I found this amazing Apna Loan , EMI calculator , Its nice

You will actually pay total of 45,000 * 12 * 20 = Rs 1.08 Crores .

Now you may feel that the cost of house is Rs 50 Lacs ,but the amount outgo is actually 1.08 Crores and may feel bad for this , But this is ridiculous . Because you are not paying 1.08 worth of money in your entire tenure , 1.08 is just a number .

Its worth is still 50 lacs only spread over 20 years and the numbers sum up to 1.08 crores .

If you calculate NPV of the Home loan money which you are paying , its exactly 50 Lacs . Calculate it with (.75% interest and 240 as tenure , as its a monthly and not yearly) .

Note : There can be other situations also where we need to calculate Net present value with a different formula , but for this post we are only discussing the examples and scenarios where you need to pay or receive a fixed amount after every fixed period for some tenure .

You can also look at Video below to learn other aspects of NPV and IRR (I have discussed it in the post : How to manage ULIPS ?

Conclusion :

You can also use this concept for taking decisions in scenarios where you have different choices of payments , choose the one which has lowest Net Present Value , like in the example we took , For the friends its more beneficial to go for the 3rd option . So the moral of the story is that dont pass this post link to your friends with whom you have financial relations :)

Questions ?

Should Banks state net present Value of the money customers pay as loan , so that people come to know that they are getting fair value for there money ?

Read interesting note on Home Loan EMI , Read how Home Loan EMI is Calculated ?

Readers , are you getting a horizontal scroll bar when you view this blog ? If its irritating for many people I will fix it ? It depends on your computer resolution how does it look to you , for me , it works fine .

– Subscribe to jagoinvestor google groups

– Follow me on twitter

– Please leave your Comments/suggestions/disagreements .

What do you want to read about
Mutual Funds Life Insurance BankingHealth Insurance Credit Report and ScoreMost Commented ArticleReal Life Experiences Share MarketLoans Real Estate Income TaxCredit Cards For Begineer Investors Succession Laws EPF ULIP Product ReviewsBest of Jagoinvestor Other Products & Concepts How-TO GuidesBooks, Launches, Initiatives Investors Myths Psychology & Wisdom PPF General

{ 8 comments… read them below or add one }

1 sachin December 4, 2009 at 5:07 pm

I have query with regards to home loan.
The banks are calculating rate or interest = PLR + Sread
Now PLR is defiend by RBI…can banks have the PLR which is of much higer value than defined by RBI…


2 manish December 4, 2009 at 6:17 pm

yes .. Bank have their own PLR which tracks the PLR befined by RBI , when RBI decreases the rate , Public banks generally also lower their PLR soon , but Pvt banks do not do it fast .



3 Ken March 2, 2010 at 8:54 pm


How much should I save monthly for the next 5 years so that I get a sum of Rs.15 lacs on the 61st month? is there a simple formula to reverse calculate?

Thanks in advance!


4 Manish Chauhan March 2, 2010 at 9:27 pm

Ken , you should look at and try to put a particular “r” for which your equation satisfies .



5 Yash Dubey January 8, 2012 at 11:59 am

An eyeOpener for many, head opener for some..

Calculations made simple..


6 Manish Chauhan January 9, 2012 at 10:36 am

Thanks Yash



7 Shobaan December 6, 2013 at 2:05 pm

Hi Manish,

great insights. I would like to invest for my son’s educational needs, he is 5. As per the NPV eg stated by you, it looks like we should invest a lesser premium amount for a longer term holds the key to reap benefits? Please correct my understanding!


8 Manish Chauhan December 12, 2013 at 2:57 pm

Yes, you need to invest for long term


Leave a Comment