Net Present Value / Intrinsic Value

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BargainHunter99
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Net Present Value / Intrinsic Value

Post by BargainHunter99 »

Hello,
Is anyone familiar with the calculation?
I have seen several ways of calculating net present value (NPV). The gas station example has the cash flows at 100,000 (ten years) and discount rate is 10%. So the net present value for ten years is $614,456 (Call this "Total").
Parameters: Gas station bought at $500,000. Gas station sold ten years later at $250,000.
My question is I see several versions of these calculations,
Once they have the Total(NPV) = 614,456. They subtract using the initial investment cost of business and another method is adding the discount factor (10th year) of the estimated sale of business
One example,
Total - Initial investment = 614, 456 - 500,000 = 114,456
Another example (Pabrai's method in Mosaic),
Total + Sale Price = 614,456 - (250,000* (1+.10)^10) = 710,842.

Sorry if this is confusing
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ghariton
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Re: Net Present Value / Intrinsic Value

Post by ghariton »

If I'm following you correctly, the answer is that you should do both, except that one has the wrong sign.

You have eleven positive cash flows, the profit for each year plus the proceeds of sale at the end of the tenth year. Discount all of these to the present, with the proceeds of sale being discounted for the entire period. Add all the present values.

You also have one negative cash flow, at the beginning. Since it is at the beginning, you do not discount it. You simply subtract it (since it is a negative cash flow). If you had other negative cash flows, which you don't in your example, they should also be discounted to the present and subtracted, to get your net present value.

Of course, complications abound. For example, there are no taxes in your example. Their treatment can be controversial.

George
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BargainHunter99
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Re: Net Present Value / Intrinsic Value

Post by BargainHunter99 »

Hi,
The net present value for ten positive cash flows at a discount rate of 10% is $614,456. The second example should have a positive sign.
When you say I should do both? Are these two calculations/interpretations the same thing?
The first example:
Total - Initial investment = 614, 456 - 500,000 = 114,456 ; NPV > 0, the investment would add value; NPV < 0, the investment would subtract value (Wiki)
The second example:
Total + Sale Price = 614,456 - (250,000* (1+.10)^10) = 710,842. If this initial investment is valued at $500,000, it is below its intrinsic value, therefore having a margin of safety.

The first example, I see on websites when talking about net present value. The second example I see on websites when talking about intrinsic value.

Thanks again for your response.
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Peculiar_Investor
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Re: Net Present Value / Intrinsic Value

Post by Peculiar_Investor »

Welcome to FWF.
BargainHunter99 wrote: 14 Jan 2018 23:28 The first example, I see on websites when talking about net present value. The second example I see on websites when talking about intrinsic value.
Perhaps if you provided links to those websites there would be more context to attempt to figure out what you are asking and why it is so confusing.
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ghariton
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Re: Net Present Value / Intrinsic Value

Post by ghariton »

I second P_I's suggestion that links to the websites you are consulting would be helpful.

Meanwhile, I read your example as follows. There are three categories of cash flows (1) the initial outlay of $500,000, a negative cash flow at the beginning (2) annual profits for ten years, which have a present value (discounted for time) of $614,456 (3) the proceeds of disposing of the gas station at the end of ten years for $250,000, for a present value of $250,000 divided by (1 + I) ^ 10.

The second and third cash flows are positive and should be added. The first cash flow is negative, and should be subtracted. The result is the net present value of investing in the gas station. If it is positive, it is a good investment, all other things considered (and there are a lot of other things).

The first calculation you show includes only cash flows (1) and (2). Cash flow (3) is missing, perhaps on the assumption that you won't be able to get anything for the gas station after all. But generally the gas station should have some residual value, and that is missing. So the calculation as you show it is wrong.

The second calculation you show includes cash flows (2) and (3) but not cash flow (1). From the little you say, it is implicit that the result of adding (2) and (3) together will then be compared to cash flow (1). I.e. cash flow (1) is included at a later stage. The result is that, after completing all the stages, you will once again have a net present value, the same as in the first calculation (correctly done).

George
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BargainHunter99
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Re: Net Present Value / Intrinsic Value

Post by BargainHunter99 »

Here are the links I have found:
Net Present Value:
A corporation must decide whether to introduce a new product line.
https://en.wikipedia.org/wiki/Net_present_value (Does not subtract total initial investment cost)
https://www.investopedia.com/terms/n/npv.asp (Does subtract initial investment cost)

Intrinsic Value:
See Table 7.1
https://www.safalniveshak.com/dhandho-i ... sic-value/
https://www.safalniveshak.com/smart-peo ... ue-part-1/

I appreciate the assistance.
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kcowan
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Re: Net Present Value / Intrinsic Value

Post by kcowan »

Would it not be better to add the estimated remediation costs to both calculations?
For the fun of it...Keith
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