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118 Part II: Using Formulas and Functions

Be sure that you convert the answer returned by the NPER function in months to
the equivalent years.
8. Check your answers against those in the equivalent worksheets in the Solved8-1.
xls workbook located in your Chapter 8 folder in the My Practice Spreadsheets
folder or on the Excel Workbook CD-ROM. If everything checks out with your
financial formulas, proceed to step 9.
9. Position the cell cursor in cell A1 of the FV worksheet and then save your work
in a new workbook file named Solved8-1-mine.xls in your Chapter 8 folder and
then close both this new workbook and the Solved8-1.xls workbook file.

The NPV function returns the sum of any series of cash flows, discounted to the pres-
ent day, using a particular discount rate. The cash flows tracked by the NPV function
are either income (money you make) indicated by positive numbers in the function’s
values argument or payments (money you pay out) indicated by specifying negative
numbers.

When using the NPV function to determine the wisdom of an investment, you keep in
mind that this function assumes that the cash flows (be they income or payments) speci-
fied by the values argument(s) are all made at the end of the first period. As this assump-
tion does not conform to the understanding of net present value in standard accounting,
when using this function, you always need to include a Time 0 (even if its value is $0) in
order for your answer to be in accord with the accepted definition of NPV.

In the next exercise, you get an opportunity to practice using both the NPV and IRR
functions (Internal Rate of Return) to determine the advisability of making certain
capital expenditures in the form of equipment purchases. The IRR function returns
the interest rate received for an investment consisting of cash flows (income and pay-
ments) made at regular intervals. Note that unlike when using the RATE function, the
cash flows do not have to be equal, although they must be made regularly on a peri-
odic basis (monthly, quarterly, annually, and the like).

The IRR function computes its result using an iterative process (similar to that used
to resolve certain circular references like the one you encountered in Chapter 6). For
this reason, the function takes an optional guess argument, where you may specify
your best guess or target percentage. If you don’t specify a guess argument for an IRR
function, Excel automatically uses 10% as its target.

To determine the prudence of making the proposed capital expenditures using the
NPV and IRR functions in exercise ahead, you finish creating a partially constructed
spreadsheet model on NPV & IRR worksheet in the workbook file Exercise8-2.xls.

Try It

Exercise 8-2: Building Formulas with the IRR and NPV Functions
Open the Exercise8-2.xls workbook file inside your Chapter 8 folder in the My Practice
Spreadsheets folder on your hard disk or in the Excel Workbook folder on the work-
book CD-ROM. In this exercise, you finish the model constructed on its NPV & IRR
worksheet. In doing so, you get practice using the NPV and IRR functions to deter-
mine the financial wisdom of making capital expenditures in the form of purchased
equipment given the level of anticipated of income resulting from the asset acquisi-
tion, the anticipated taxes on that extra income, and the depreciation of those assets
over their three year life: