How to Calculate the Cumulative Present Value
- 1). Select a discount rate. Generally you'll match the discount rate to return rates you could earn in alternative investment opportunities.
- 2). Determine or estimate the net cash flow for each month, year or other time period of an investment or project. To simplify this discussion, presume that the remaining steps are for end-of-year cash flows. So, for example, if this is Jan. 1, 2010, and you want the cumulative present value of the cash flows for the next four years, then you'll solve for revenue minus expense within each year, starting with the Jan. 1, 2010, to Dec. 31, 2010, time period.
- 3). Divide each year by (1+i)^n, where i is your chosen interest rate in Step 1 and ^n means the based is raised to the n-th power. How you vary n can be a matter of judgment or how you're finding the present value of other investment opportunities to keep the comparison apples-to-apples. Looking at just the first year, from 1/1/10 to 12/31/10, you could slot it back from the middle of the year to 1/1/10, so that n=1/2 for the first year. Or you could n=0, effectively not backing out any (equivalent) interest return at all. For the rest of this discussion, present-valuing will be done from mid-year to the present. For example, if the cash flow for the third year (1/1/12 to 12/31/12) is $123,000, then you'd divide $123,000 by (1+i)^2.5.
- 4). Sum up the present value of each year's cash flow to get the cumulative present value. In other words, sum up the results for each year in Step 3.
