Suppose now we want to invest in a new venture, with considerably more
risk than investing in state bonds. This increased risk is represented by a
higher interest rate. In addition, the interest rate is also affected by cost
of capital , since most companies must do some work to find the
money to do the investment. High risk and high cost of capital are
reflected in a high interest rate used for discounted net present value
computations.

Suppose we value our risk at 20%. Using this percentage, the net cash
flows generated a few years from now discount to a smaller net
present value, as shown in table 7.3. With this amount of risk, the
investment seems not to be such a good idea, since the investment
results in a negative DNPC. For an investment with risk valued at
20% to be profitable, yearly net revenue should have been much
greater.

Table 7.3:Calculation of discounted net present cash value over a series
of time periods using 20% interest

Period

Revenues

Expenses

Investments

DNPC

0

1,000

-1,000

1

500

100

333.33

2

500

100

277.78

3

500

100

231.48

Total

-157.41

A frequent mistake while calculating the DNPC is to include
depreciation costs [3]. However, depreciation costs do not lead to direct
expenses. Rather, the upfront investment for which depreciation cost are
made has already been taking into account while doing a DNPC
calculation, so considering depreciation costs also, would lead to double
counting.

Finally, it is important to understand a few assumptions while
calculating net present discounted cash flows. First, the cash (revenues
and expenses) should directly relate to the investment made.

Second, the calculation supposes that positive results of a contract
period in a time series can be invested with same interest rate, as was
used for the calculation.

Third, the calculation supposes that cash flows are only occurring at
specific points in time, namely at the end of each contract period.
Obviously, that is not always the case in real-life, but a simplification is
made here to allow for easy calculation.