Articles, Blog

Net Present Value with the HP 12C

October 11, 2019


The Hewlett Packard 12c financial
calculator is a pretty handy, pretty sophisticated tool. In fact you can do
net present value and internal rate of return calculations on this calculator.
This video will walk you through using the blue keyboard and the gold
keyboard to make those calculations. First of all, big picture, why do we need
to know the net present value? Why do we need to know internal rate of return?
Remember on a company’s balance sheet on the right hand side is what it owes. And
then the difference between what it owns, on the left-hand side, and what it owes,
on the right hand side, is the equity in the business. And all this capital on the
right-hand side of the balance sheet has a cost. We’ll calculate the after-tax cost
of money on the right-hand side. That’s called the weighted average cost of
capital and we’ll need to earn at least that much when we put new assets on the
left hand side. So I’m gonna try to remember to put a link in the
description of this video that will send you to a short video about calculating
weighted average cost of capital. But big picture, we’re trying to put assets on
the balance sheet that earn more than what our capital costs us. When we’re
doing net present value and internal rate of return calculations, we’re gonna
use the blue keyboard, specifically the G CFo, the G CFj and the G Nj. This CFo
is for the initial cash flow. This is for each of the future cash flows and if your cash flow repeats, we’ll use the Nj. It isn’t 100% necessary
that you know this, but what the calculator is gonna do is it’s gonna
take that information that we give it and it’s gonna store it. For instance, that
CFo data is in this register here – zero. The first cash flow will be in the
register one, register two, register three, etc. And if we go past ten, it’ll use
point zero for eleven, point one for twelve, etc. And even if we run out of
those storage registers, the calculator is going to use the FV as, kind of like, a
last stop for memory storage. It’s also going to
use this “n” key to index all the things that we’re doing. And you only need to know
that all that information if you ever have to go back and change anything. Okay,
let’s pretend like we’ve figured out that our weighted average cost of
capital is 8% – our money on the right-hand side of our balance sheet
costs us 8%. We want to enter into projects, we want to make investments, we
want to do things on the left-hand side of the balance sheet that return more
than 8%. So let’s put these hypothetical cash flows into our calculator. I’m gonna
hit F clear registers. Technically you don’t have to do that because the
calculator is supposed to be smart enough to only use the new stuff that
you put in. But I just like to start with a clean slate every time. So 130,000
dollars is the initial cash flow OUT. So we’re gonna change the sign to make
that cash out and then we’re gonna hit G CFo. So we’ve told the calculator the initial cash outflow is one hundred and thirty
thousand dollars. Next is seven thousand dollars IN. Seven
thousand dollars G CFj. It doesn’t repeat. Ten thousand dollars out, so we’ll
change the sign on it G CFj. And so the facts are usually we buy a new
machine and after the first year we have to remodel it, so we have to invest some
cash. Then we get twenty thousand dollars three years in a row. So twenty thousand
dollars. There, I could hit twenty thousand dollars CFj, twenty thousand
CFj, twenty thousand dollars CFj, but there’s a shortcut key. i can just hit
three G Nj and that tells the calculator this is a group cash flow (a repeating
cash flow) and it repeats three times. Next we got $12,000 in, then eight
thousand dollars out and one hundred and seventy eight thousand five hundred
dollars in. Let’s check ourselves. Let’s see what the
cash flow at one is. So we’ll hit recall 1, and sure enough there’s our $7,000. So
like I say, the calculator uses the memory registers over here to store
these cash flows. And if it runs out of memory registers over here, as a
last-ditch effort, it will use the FV to store one final cash flow. Let’s plug in
the interest rate 8 i. And then hit F NPV – eleven thousand four and twenty nine dollars.
Since it has a positive net cash flow, we do this project. Doing this
project adds eleven thousand four and twenty nine dollars worth of value to
our company. In case it helps you, what the calculator did was it took the
initial cash flow (which was a negative number) and added to it the present value
of each of the future cash flows and gave us the NET present value. We
could also have found the internal rate of return. That’s the discount rate at
which the present value the future cash flows is exactly equal to the initial
cash outlay – or what the project earns. Let’s hit F IRR and it tells us that’s
nine point three seven. Since that’s more than eight percent, we do it. So the good
news about the IRR calculations is it’s easy to understand. Even a marketing
major gets that if your money costs eight percent and you invest it to earn
nine point three seven, that that project is a go. The bad news is if there’s
changes of signs here in these cash flows, there may be multiple solutions to
the equation whereby the i is the right amount to make the future cash flows
have a present value exactly equal to the initial two cash flow. And the other
one is that it can lead to some misleading decisions on mutually
exclusive projects. You might undertake a smaller project that has a higher rate
of return but that means you’re not getting as much value dollar-wise added
to your company. If you want to change one of the cash flows you simply look at
whichever one it is. Like recall one here. If you wanted to change
that to $8,000 you would something hit eight thousand store that in one. If you
need to change the number of repetitions for a cash flow, first set the “n” for
the cash flow PREVIOUS. Then hit the GNj key for the correct amount of
repetitions. Alright let’s see if we can check our work using Excel first let’s
check our IRR calculation. There’s nothing tricky about that in Excel. It’s
=IRR, and then you designate the values close it up and there’s our nine
point three seven percent. Now let’s check the NPV and that’s just a tiny bit
trickier. We’ll tell Excel=NPV. It wants to
know a rate. We’ll hit point zero eight. And then it wants to know the values.
We’ll tell it these values. We’ll close up the parentheses and lo and behold we
get the wrong answer because Excel assumes that this first cash flow is
received at the END of the first period. So we’ve got to take this whole answer
here and what we’ve got to do is we’ve got to move it forward one period. And I
like to do that by multiplying it times one plus the interest rate, which is one
plus point zero eight. And so hopefully when I hit enter, we get exactly the
right net present values. So when you go to check yourself in Excel remember that
Excel assumes that that first cash flow is made at the END of the first period
when in fact it’s made at the BEGINNING of the first period. I hope that helps. you

You Might Also Like

No Comments

Leave a Reply