Net present value is calculated by taking the sum of an investment's anticipated cash inflows and outflows. A present value factor is applied to the cash flows to account for the time value of money, under the premise that a dollar held today holds more value than a dollar received any time in the future. This is because the dollar can be invested in a risk-free investment, such as a Treasury bill, and earn an investment return. In calculating net present value, the discount rate used to calculate present value is the required rate of return on your investment.
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Identifying Cash Flows
Identify the expected cash inflows and outflows associated with the rental property. Costs already incurred prior to the analysis are ignored, as they are considered sunk costs. The primary inflow would be derived from rent, although you may also need to factor in late or other sundry fees. Outflows may include mortgage costs, property tax expenses and repairs and maintenance costs. It is important that you accurately estimate the cash flow amounts as well as the timing of the inflows and outflows.
Net Present Value Calculation
Use a spreadsheet to prepare your net present value calculation, beginning with a section summarizing your assumptions, such as your discount rate. This allows you to link to the assumptions within the spreadsheet formulas you input, so you don't have to repeatedly enter them manually for each calculation. In an orderly manner, enter in your cash flow estimates so they reflect the proper time frame. The present value factor for all cash flows is calculated as: 1/(1+r)^n, where "r" is the discount rate and "n" is the time period, which you can enter as months. Therefore, if a cash flow is received at month 6, "n" would equal 0.5. If r equals 10 percent, and n equals 0.5, the present value factor equals 0.9534. Multiply this present value factor by the applicable cash inflow and outflow, and take the sum of all present values. The result is your net present value.