Investment Science: Computing Net Present Value of a cash flow stream using a financial calculator

Thursday, August 19, 2010

In this short article, we will see how to use a financial calculator to compute the Net Present Value of a cash flow stream, the financial calculator used for illustrating this example is Texas Instruments BA II Plus.

For more details on computing Net Present Value of a cash flow stream, refer my  previous article.

Consider a cash flow stream (-2, 1, 1, 1) , the Net Present Value of this cash flow stream at an annual interest rate 10% is given by

NPV = -2 + 1 / (1.1) + 1 / (1.1 ^ 2) + 1 / (1.1 ^ 3)  = 0.48685

To calculate the Net Present Value of the above cash flow stream with a Texas Instruments BA II Plus Financial Calculator, follow the below steps.

1. Reset previous cash flow streams if any in the calculator (read the -> below as a sequence)

Use the following keys: 2ND -> RESET -> ENTER

2. Set the number of decimal places in the financial calculator

By default, the number of decimal digits displayed is 2 and often you need a better precision for a computation like NPV, therefore, set the number of decimal places to atleast 4, for doing this

Use the following keys: 2ND -> FORMAT -> 4 -> ENTER

3. Compute Net Present Value: Now we are ready to enter the stream of inputs for the cash flow stream (-2, 1, 1, 1) with interest rate 10% for computing Net Present Value, for this use the following keys

3.1   CF -> 2 -> - (Minus key) -> ENTER ->

3.2   (CF1 appears) 1 -> ENTER ->

3.3   (F01 appears with a default value 1, accept it as it is) ENTER ->

3.4   (CF2 appears) 1 -> ENTER ->

3.5   (F02 appears with a default value 1, accept it as it is) ENTER ->

3.6   (CF3 appears) 1 -> ENTER ->

3.7   (F03 appears with a default value 1, accept it as it is) ENTER ->

3.8   (CF4 appears) Now Press NPV key

3.9   (I= appears, now enter the yearly interest rate) 10 -> ENTER ->

3.10 (NPV appears) Press CPT key, now NPV = 0.4869 will be displayed.

Common mistake when entering interest rate: At times when you are in hurry, it's easy to enter the interest rate as 10/100 or 0.1, but note that the interest rate is already accepted as a percentage value, also when the interest is compounded more than once in a year, enter the interest rate value as yearly interest rate divided by the number of periods (for a 10% annual interest rate compounded monthly, this will be 10/12).


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