(http://feasibility.

pro)

Search

NVP & IRR Key Metrics of a Feasibility Analysis

(http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibilityanalysis/)
January 31, 2013 by Naiyer Jawaid (http://naiyerjawaid.com/)
Excel (http://feasibility.pro/category/excel/) , Finance (http://feasibility.pro/category/real-estate/nance/)
19 Comments (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/#comments)
Defining Feasibility Analysis
Feasibility analysis can mean dierent things to dierent people. Lets first define the term feasibility. The word
feasibility is derived from feasible, which simply means capable of being done or accomplished. And feasibility
studies aim to logically find the strengths and weaknesses of a proposed project, opportunities and the resources
required to carry through, and ultimately the prospects for success.
There can be various types of feasibility studies - Technical, Economic, Legal, Operational and Scheduling. It is
represented by the acronym TELOS.
When we talk about the feasibility analysis of a real estate project, we mostly talk about economic feasibility or
financial feasibility. It is not so that we ignore the other factors in a real estate feasibility study. Most oen we
incorporate all of them in the economic feasibility. The final result of a real estate feasibility analysis is inclusive of
technical, legal, operational and scheduling feasibility studies.
Key Metrics of a Feasibility Analysis
When we look at the final outcome of a feasibility analysis we look at the key metrics to judge the projects merit. What
should be included in the key metrics depends on the type of project, funding strategy and legal structure. The most
common metrics include Net Present Value (NPV), Internal Rate of Return (IRR), Developers Margin and Return on
Equity (RoE).
In this post we are going to cover the most basic of them - Net Present Value (NPV) and Internal Rate of Return (IRR).
What are NPV and IRR?

NPV and IRR are two very basic metrics of a feasibility analysis. They are easy to understand and it is fun to work with
them.
The Net Present Value (NPV) is defined as the sum of the present values of the individual cash flows (both incoming
and outgoing) of a series of cash flows. And then we ask what the Present Value is. The Present Value is defined as the
current worth of a future sum of money or stream of cash flows at a certain discount rate.
Ok, then what is the discount rate? Discount rate is a rate at which we discount the future cash flows to find present
value. It can be your cost of capital, cost of equity, desired rate of return, hurdle rate or even the interest rate a central
bank charges depository institutions. We will have a separate post entirely dedicated to discount rate.
And what is IRR then? IRR is a rate of return at which the projects NPV becomes zero.
What if you are a New Comer?
It may all sound very confusing if you are a new comer. When I explain these terms, some people complain that it is like
a circular reference in Excel.
Worry not. The professor who taught us finance is a very interesting person. When the class was over, he asked us to
define NPV and IRR. Most of us gave definitions similar to the above. He said, Think as if I am your grandmother and
now explain it to me.
So Im going to take same approach.
Suppose you have 100 $. You can either consume it or save it for future consumption. When you choose to save it for
future consumption, you will deposit it with a bank. Bank will be paying you some interest. Assume that bank is paying
5% interest annually and you will be withdrawing the interest payouts. Your cash flow will looks like this:

Business Plan Example

Download Business Plan Template Fill the Blanks & Get the Job Done!

You deposited 100$ and aer one year you got 105$. What does it mean? It means that 105$ next year is worth 100$
today.

This is the concept of present value. Calculating present value means finding the worth of future cash flow as of today.
And the interest rate we used here is referred to as Discount Rate in present value calculation.
What is Net Present Value? It is the sum of present value less the initial outlay.
Now suppose you deposited this 100$ in a deposit scheme where the interest rate is 5%, the term is 5 years and there
will be usual interest payout. What will be the present value and what will be the net present value?

First, lets understand IRR. Assume a residential building project of cost 100$. The project is constructed in a year and
from the next year we are receiving rental income of 7$. We will be selling the building at the end of 5th year for 130$.
What is the IRR?
Your cash flows will look like this:

We will now find the present value of each cash flow. We will assume a discount rate of r%.
Initial Year (Amount -100$): = -100/(1+r)^0
1st Year (Amount 7$): = 7/(1+r)^1
2nd Year (Amount 7$): = 7/(1+r)^2
3rd Year (Amount 7$): = 7/(1+r)^3
4th Year (Amount 7$): = 7/(1+r)^4
5th Year (Amount 7$): = 7/(1+r)^5
5th Year (Amount 130$): = 130/(1+r)^5

Net present value will be the sum of all of these.

Net Present Value = -100/(1+r)^0 + 7/(1+r)^1 + 7/(1+r)^2 + 7/(1+r)^3 + 7/(1+r)^4 + 7/(1+r)^5 + 130/(1+r)^5
Equating this to zero and solving for r will give us the IRR.
0 = -100/(1+r)^0 + 7/(1+r)^1 + 7/(1+r)^2 + 7/(1+r)^3 + 7/(1+r)^4 + 7/(1+r)^5 + 130/(1+r)^5
r = 11.75%
This is the IRR
Note that IRR is independent of discount rate. In fact it is a discount rate at which NPV becomes zero.
Calculating NPV and IRR in Excel
We use NPV and IRR functions in Excel and we will use the above example for the same.
First we will calculate the present value manually i.e. using the formula PV = A/(1+r)^t. The sum of the all the present
value will give us the Net Present Value.

Now we will use NPV formula of Excel. You can either type =npv in a cell or go to insert>Formulas>Insert Functions

Once you clicked Insert Functions, the function window will appear. Select Financial, and from the list select NPV and
press OK.

Now the NPV formula window will appear. In the rate box, select the cell containing the discount rate. And in the value
1, you can select the cell range containing the cash flows. Dont include the initial cash out lay. It will give you 107.26$
as the formula result.

Now subtract the initial layout i.e. the project cost by going to the cell.

Now, let us find IRR by using Excel IRR function. Go to insert>Formulas>Insert Functions; Select Financial, and from the
list select IRR and press OK.

In the value field, select the cash flow range including the initial layout. Leave the Guess field empty, Excel will assume
10% by default.

Press ok and now you have the IRR.

Calculating IRR in Excel is much easier as compared to solving the above equation for r.
Hope you enjoyed the post. In coming weeks we will discuss some advance topic related to NPV and IRR.
What do you think, use the comment section below.

Download
Download the NPV-IRR Spreadsheet

Free Download (http://naiyerjawaid.com/wp-content/uploads/NPV-IRR-Workbook.xlsx)

Tagged: Feasibility Analysis (http://feasibility.pro/tag/feasibility-analysis/) , Feasibility Study (http://feasibility.pro/tag/feasibility-study/)

IRR (http://feasibility.pro/tag/irr/) , NPV (http://feasibility.pro/tag/npv/)

Related Posts
05
Apr
2016

 0 (http://feasibility.pro/increment-irr/#comments)
(http://feasibility.pro/increment-irr/)

What is Increment IRR? (http://feasibility.pro/increment-irr/)

29
Mar
2016

1 (http://feasibility.pro/negative-irr/#comments)
(http://feasibility.pro/negative-irr/)

The Curious Case of Negative IRR (http://feasibility.pro/negative-irr/)

05
Jan
2016

 0 (http://feasibility.pro/create-hatched-charts-excel/#comments)
(http://feasibility.pro/create-hatched-charts-excel/)

How to Create Hatched Charts in Excel (http://feasibility.pro/create-hatched-chartsexcel/)

19 Response Comments
namanJuly 15, 2013 at 10:47 am

beautifully explained..!
thank you
Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=11#respond)
ysurenderNovember 14, 2013 at 6:35 am

Simple crisp fantastic explanation !

Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=54#respond)
Ali PourbozorgiFebruary 28, 2014 at 2:23 pm

Dear Sir
Thank you for your invaluable explanations. I just have one question, on the first example of NPV , should
the NPV be equal to zero or $25?
Thank you in advanced
Ali
Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=307#respond)
AliApril 12, 2014 at 1:23 pm

Beautifully explained!!!!

Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=342#respond)
Muhammad IjazSeptember 12, 2014 at 11:19 pm

Thank you sir, nicely explained.

Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=2160#respond)
SaravananOctober 15, 2014 at 8:52 am

Excellent!! Anybody can understand about IRR and NPV with your above article.
Thanks
Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=2918#respond)
DeeptiNovember 14, 2014 at 11:07 am

Thanks NaiyerKey Metrics Simplified Cheers Deepti

Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=3543#respond)
Chris AlbertApril 17, 2015 at 2:16 am

wonderful.. will be using this article in my study as i prepare for financial projections of my dads business.
Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=8868#respond)
PSMay 7, 2015 at 4:08 pm

Naiyer, when you are finding the present value of each cash flow in your example, should it not be
5th Year (Amount 130$): = 130/(1+r)^5, rather than 5th Year (Amount 130$): = 7/(1+r)^5
I.e. 130 not 7?
Cheers
Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=9481#respond)
Naiyer Jawaid (http://naiyerjawaid.com/)May 7, 2015 at 5:29 pm

Thanks PS. Corrected.

Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=9485#respond)
amritaMay 19, 2015 at 12:53 pm

hi,
can you please also explain how can you calculate IRR in excel
Regards,
Amrita
Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=9535#respond)
Naiyer Jawaid (http://naiyerjawaid.com/)May 19, 2015 at 3:53 pm

It is explained in this post itself Amrita. If you any specific question, please let me know.

Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=9536#respond)
Sandip TiwariMay 20, 2015 at 5:05 pm

very well explained sir!

Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=9543#respond)
Abu VNovember 4, 2015 at 6:00 am

Simple explanation and well presented

Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=10877#respond)
AymanMarch 10, 2016 at 11:56 am

In feasibility study IRR

In the case of the Project financing by loan we must added the loan value in cash inflows or not please
explan
Reply (http://feasibility.pro/nvp-irr-key-metrics-of-a-feasibility-analysis/?replytocom=11972#respond)

Leave A Comment
Name (required)
Email (required)
Website
Comment...

PostComment

Structuring Real Estate Deals (http://feasibility.pro/structuring-real-estate-deals/)

Product Mix Optimization (http://feasibility.pro/product-mix-optimization/)

Stay in touch!
emailaddress

emailaddress

Subscribe

Hello There!
Hello! and welcome to my blog. This is so exciting you are here.
I blog about Real Estate Finance, Investment and Excel on Feasibility.pro.
I love to meet new people and share knowledge. Mail me if you would like to get connected, or
read more about me. (http://feasibility.pro/about/)
Or ask me anything about real estate on
Or connect with me on Linkedin

(http://www.quora.com/Naiyer-Jawaid)

(http://qa.linkedin.com/in/naiyerjawaid)

(http://feasibility.pro/forum/)

Simple Fuel Gas Treatment

Membrane Fuel Conditioning System Cleans gas for compressor stations

(http://feasibility.pro/forum/)
Copyright2016(http://feasibility.pro/forum/)Feasibility.pro(http://feasibility.pro/)Allrightsreserved.