Introduction

Welcome to Net Present Value training with VLU. This video is designed to give you a better understanding of what Net Present Value is, and the different methodologies used to generate it.

The the end of this course, you should be able to:
• Understand how Net Present Value is utilized in accounting
• Know how Net Present Value is calculated
• And how to calculate Net Present Value for mid-period payments.
Please Take a moment to review the agenda. If you are looking for a specific topic, feel free to jump to the corresponding timestamp.

Understanding Net Present Value (NPV)

In this video, we will discuss how Net Present Value, or NPV, is used in accounting and how it is calculated.

NPV is a capital budgeting method used as part of the Cost Benefit Analysis to determine the profitability of an investment. It is an essential tool for assessing the viability of investments by accounting for the time value of money. This way, you can compare the investment cost in today’s dollars and the value of the expected return.

NPV can be applied to your lease liability by applying an incremental borrowing rate to determine the present value of the lease payments. Applying the formula will give you an interest and principle as if your lease was a loan.

Things to consider for the formula:
• Number of periods in the calculation
• The Interest or Discount rate
• The Present Value or what the money is worth today
• The regular payments being made
• And what is the future value or in other words, what is the dollar worth at the end of this time being calculated

For example, buying a house:
• You take out a 30 year loan, so you know the number of periods is 360 (months)
• You know the interest rate the bank will charge
• You know the present value, or, the amount of money being borrowed
• You know the future value will be zero since the loan will be amortized down
• So with all this information, we need to solve for the payment amount

So with that, the formula can be explained as follows:
• Net Cashflow at a point in time (Rt)
• Over 1 + i (or interest) to the power of the number of periods

In order to use this formula you will need to find the information needed for it. But where can it be found? It can be found in the visual lease abstract report.

Please note, this report is color coded for illustration purposes only. The report will not contain these colors.

Here, the interest rate is highlighted in Blue (i). Scrolling down further we have the period in red, the payments in yellow, and scrolling all the way down to the bottom of the calculation, the liability will display as zero, which is the future value, highlighted in light blue. With this information we can solve for the present value (7:26)

NPV for Individual Months

In this video, we will discuss the different methodologies for calculating present values for individual months, and why they are different.

The Present Value for individual months can be calculated with two different types of methodology. The first is using the Beginning of Period, and the second is using End of Period methodology. Each methodology will give slightly different results. (8:10)

Please note: It is important to use the same calculation method that is used for making the interest charges.

In beginning of period methodology, the interest is calculated based on the payment being made at the beginning of the month. Take the ending balance from the previous month, subtract the payment, and then multiply by the interest rate.

Note: The payments included in this methodology start with payment number 2. The first payment cannot be discounted in this formula and needs to be added at full face value.

In end of period methodology, the interest is calculated for payments made later in the month. Multiply the ending balance by the interest rate, then subtract the payment.
Both methods are allowed under all reporting standards. It may be more appropriate to use the method that most closely matches when you make payments. However, the most important thing is to be consistent. If you are unsure of which method your organization uses, or which you should use, consult with your ERP.

Visual Lease supports both methods and should be set up during implementation. It can be changed in Administrator at any time; however, only make this change if you are confident that it must be done.

Note that in Visual Lease, Beginning of Period is selected by default. If the calculations done in Visual Lease do not match those done in another tool, such as Microsoft Excel or your ERP, check which methods each platform is using. Excel uses End of Period by default.

If you are using a variable period calendar such as a variant of 4-4-5, or a 13-period calendar, the calculations will be done slightly differently. Visual Lease calculates these calendars daily rather than monthly. This may cause some discrepancies in the reported values.

Consult with your ERP to determine if an adjusting entry is needed.

Calculating NPV with Mid-Period Starting Points

In this video, we will discuss calculating present value when payments that are recurring in the middle of the month instead of at the beginning of the month.
In Visual Lease, the date of the payment is an important date because it will be assigned to that period where a period is considered a month. The platform uses the convention that payments are made at the beginning or end of each period (or month).

For example, there is a mortgage on house for $2000. The payment is made in February which only has 28 days. However in March, the same $2000 payment is made even though there is 31 days in that month. The reason the payment is larger in march is because the platform uses the convention that months are equal periods. There is nothing smaller than a month, or in other words, for NPV, the number of days are not considered.

For example, the lease payments are all 10,000 a month, then this one that is paid in the middle of the month. However in the P&L column here, it displays the prorated amount to account for the mid-month payment. But the cash payment is still the same for each period.

If calculating a straight forward NPV using Beginning of Period methodology, the NPV calculation will not agree with the platform calculation. Why is this happening? Because the first period payment happened mid month, and the second payment was made for the 2nd period, but it was only 12 days later instead of a full period. So how do we fix that? We add a new period number that is 12 days of a 31 day month. Then all numbers after that are the full period plus that fractional amount.

As a result, a slightly different formula needs to be used to account for that.

Instead of NET present value. We use the PRESENT VALUE of that single payment. To do this, take the discount rate divided by the number of periods for the per period discount rate, in this case 12. Then take the period number, payment is blank, minus the amount of the payment as a future value, which will then solve for the Present Value. Adding all the present values will then give the Net Present Value, which will then be in agreement with the platform for Total Ending Liability.
To sum it up the process, follow these steps when solving for NPV with a mid-month payment:
1. Use the Beginning of Period Methodology
2. Understand the first payment has no discount factor
3. The second payment is based on the # of the payment was made mid-month, in our case it was 12 out of 31 days, which is calculated as a fractional payment
4. Each subsequent period should be 1 more than the prior period.
a. So you should have the initial fractional period, +1 period, + 1 period, continuing to the current payment
5. Solve for present values
6. Sum the present values to get in agreement with the ending liability.

Key Takeaways

This concludes the video on Net Present Value.

Remember:
• All the numbers needed for the NPV formula can be in the abstract report
• It is important to select an NPV methodology that is consistent. In other words, don’t use two different methodologies or you will receive inconsistent results
• NPV can be calculated for mid-period payments but extra steps need to be taken in order to account for the fractional payment.
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Thanks for watching. Any questions, suggestions, or feedback can be sent to support@visuallease.com