How to Calculate the NPV of a Lease Report

bizfluent article image

lease image by Renato Francia from Fotolia.com

If you understand the value of money, you also understand the theory behind the present value of future cash flows. Almost any stream of payments (loan or lease) is composed of regular, fixed payments to the lender or owner of an asset. This series of payments is determined by the size of the lease which is, in turn, determined by the most recent lease report and prevailing interest rates. The net present value (NPV) of these lease payments is the value of the lease contract.

Review the calculation to determine NPV. The formula for finding the net present value of future lease payments on a contract is: (PV) = C * [(1 - (1 + i)^ - n) / i].

PV = present value, C = the cash flow each period, i = the prevailing interest rate and n = number of lease payments.

Define your variables. Let's assume you want to find the present value of a lease with payments of $500 due at the end of the next three years at an interest rate of 5 percent. These variables are found on the lease report. That is, the lease term is three years. The variables in the equation are: C = $100, i = .05 and n = 3.

Calculate the year 1 present value of cash flow. Year 1 cash flow = C ($C) / (1 + i))^ n. This equals $500 / (1.05)^3, or $476.19. The present value of $500 in 1 year is $476.19 at 5 percent interest.

Determine the year 2 present value of cash flow. This equals $500 / (1.05)^2 or $453.51. The present value of $500 in two years is $453.51 at 5 percent interest.

Calculate the year 3 present value of cash flow. This equals $500 / (1.05)^2 or $431.92. The present value of $500 in three years is $431.92 at 5 percent interest.

Total the present value for all three years. The net present value of future cash flows is $476.19 + $453.51 + $431.92 = $1361.62; that is, the present value of $500 lease payments from a three-year contract with 5 percent interest is $1,361.62.