The #1 mistake with running the NPV calculation for an acquisition of an existing property is to accidentally discount the Time Zero investment amount. By definition, at Time Zero, the nominal value is the real value, so we do not want to discount it.
Since the Time Zero investment amount is a negative cash flow (representing the cash investment), if we mistakenly discount it, we are effectively reducing the size of the investment, AND we are discounting each of the future period positive cash flows one time too many, which will then make our project NPV seem worse (lower) than it actually is (because the returns cash flows were interpreted to be smaller real dollar amounts than what they should have been).
The takeaway: make sure that you do NOT capture the Time Zero value in the range of values which you are discounting in the formula. Only capture the projected (future, non-Time Zero) values, and then close the parentheses and THEN add the Time Zero amount outside of the parentheses.
Note: to get the cells to light up in the embedded example below, you’ll need to download it by clicking on the Excel icon in the bottom of the embed border.
Enjoy, and post any questions below.
how do you pick the correct discount rate? what is reasonable? is it different for each asset class?