How do you calculate net present value (NPV) of a multi-year income property investment, and what discount rate should be used?

• A. NPV = sum of (net cash flow / (1+r)^t) minus initial investment; discount rate equals the investor’s required rate of return (risk-adjusted cost of capital)
• B. NPV = sum of cash inflows without discounting; discount rate is the expected inflation rate
• C. NPV = initial investment minus sum of net cash flows; discount rate is the loan interest rate
• D. NPV = terminal value / (1+r)^t; discount rate equals the cap rate used for terminal value

Answer: (A)

NPV measures whether an investment adds value by bringing future net cash flows back to present dollars and comparing that to the upfront cost. For a multi-year income property, you project the net cash flow for each year (rental income minus operating costs, reserves, taxes, and any other relevant items) and discount each year's amount back to today using a rate that reflects the investment’s risk and your required return. The standard calculation is to sum the present value of all yearly net cash flows, then subtract the initial investment. The discount rate should be your required rate of return, essentially the risk-adjusted cost of capital, which captures the opportunity cost of tying money into this project versus alternatives with similar risk. This approach correctly accounts for the time value of money and risk.

Other options misapply the concept: discounting inflows without reducing them to present value inflates value; subtracting cash flows from the initial investment reverses the relationship; using the loan interest rate ties the rate to financing rather than investment performance; and using a terminal value divided by (1+r)^t with a cap rate is a different valuation approach and not the standard NPV calculation.