Net Present Value (NPV)

Definition: 

Net present value (NPV) calculates the current value of all future cash flows of an upcoming investment or project. Simply put it measures Today’s value of the expected cash flows − Today’s value of invested cash

Why is it important? What is it used for?

It’s a way to predict your return on investment (ROI) for a project or expenditure. By looking at all the money you expect to make from the investment and translating those returns into today’s dollars, you can decide whether the project is worthwhile.  

What is NPV example?

Visit calculatestuff.com/financial/npv-calculator for a comprehensive NPV example scenario. 

How Is NPV Calculated?

Because the time value of money dictates that money is worth more now than it is in the future, the value of a project is not simply the sum of all future cash flows. Those future cash flows must be discounted because the money earned in the future is worth less today. Fortunately, there is a function in Excel that will calculate NPV for you, but if you want to understand the math behind it, this is the basic formula which assumes a constant cash flow from one project:

NPV = ( cash flow / ((1 + discount rate) * time periods)

What is a good NPV?

A good NPV (Net Present Value) is a positive value.  A positive NPV indicates that the investment is expected to generate more cash flow than the initial investment, making it a good investment. Conversely, a negative NPV indicates that the investment is expected to generate less cash flow than the initial investment, making it a poor investment.

What is the difference between NPV vs. Internal Rate of Return (IRR)?

NPV calculates the present value of future cash flows while IRR calculates the rate at which future cash flows can be discounted to give a net present value of zero.

In general, a higher NPV or IRR is considered better, as it indicates a higher profitability for the investment. However, NPV and IRR can sometimes lead to different conclusions about the desirability of a particular investment, so it's important to consider both metrics when evaluating a potential investment.