What is 'Net Present Value  NPV'
Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of a projected investment or project.
The following is the formula for calculating NPV:
where
C_{t} = net cash inflow during the period t
C_{o }= total initial investment costs
r = discount rate, and
t = number of time periods
A positive net present value indicates that the projected earnings generated by a project or investment (in present dollars) exceeds the anticipated costs (also in present dollars). Generally, an investment with a positive NPV will be a profitable one and one with a negative NPV will result in a net loss. This concept is the basis for the Net Present Value Rule, which dictates that the only investments that should be made are those with positive NPV values.
When the investment in question is an acquisition or a merger, one might also use the Discounted Cash Flow (DCF) metric.
Apart from the formula itself, net present value can often be calculated using tables, spreadsheets such as Microsoft Excel or Investopedia’s own NPV calculator.
BREAKING DOWN 'Net Present Value  NPV'
Determining the value of a project is challenging because there are different ways to measure the value of future cash flows. Because of the time value of money (TVM), money in the present is worth more than the same amount in the future. This is both because of earnings that could potentially be made using the money during the intervening time and because of inflation. In other words, a dollar earned in the future won’t be worth as much as one earned in the present.
The discount rate element of the NPV formula is a way to account for this. Companies may often have different ways of identifying the discount rate. Common methods for determining the discount rate include using the expected return of other investment choices with a similar level of risk (rates of return investors will expect), or the costs associated with borrowing money needed to finance the project.
For example, if a retail clothing business wants to purchase an existing store, it would first estimate the future cash flows that store would generate, and then discount those cash flows (r) into one lumpsum present value amount of, say $500,000. If the owner of the store were willing to sell his or her business for less than $500,000, the purchasing company would likely accept the offer as it presents a positive NPV investment. If the owner agreed to sell the store for $300,000, then the investment represents a $200,000 net gain ($500,000  $300,000) during the calculated investment period. This $200,000, or the net gain of an investment, is called the investment’s intrinsic value. Conversely, if the owner would not sell for less than $500,000, the purchaser would not buy the store, as the acquisition would present a negative NPV at that time and would, therefore, reduce the overall value of the larger clothing company.
Let's look at how this example fits into the formula above. The lumpsum present value of $500,000 represents the part of the formula between the equal sign and the minus sign. The amount the retail clothing business pays for the store represents C_{o}. Subtract C_{o} from $500,000 to get the NPV: if C_{o} is less than $500,000, the resulting NPV is positive; if C_{o} is more than $500,000, the NPV is negative and is not a profitable investment.
Drawbacks and Alternatives
One primary issue with gauging an investment’s profitability with NPV is that NPV relies heavily upon multiple assumptions and estimates, so there can be substantial room for error. Estimated factors include investment costs, discount rate and projected returns. A project may often require unforeseen expenditures to get off the ground or may require additional expenditure at the project’s end.
Additionally, discount rates and cash inflow estimates may not inherently account for risk associated with the project and may assume the maximum possible cash inflows over an investment period. This may occur as a means of artificially increasing investor confidence. As such, these factors may need to be adjusted to account for unexpected costs or losses or for overly optimistic cash inflow projections.
Payback period is one popular metric that is frequently used as an alternative to net present value. It is much simpler than NPV, mainly gauging the time required after an investment to recoup the initial costs of that investment. Unlike NPV, the payback period (or “payback method”) fails to account for the time value of money. For this reason, payback periods calculated for longer investments have a greater potential for inaccuracy, as they encompass more time during which inflation may occur and skew projected earnings and, thus, the real payback period as well.
Moreover, the payback period is strictly limited to the amount of time required to earn back initial investment costs. As such, it also fails to account for the profitability of an investment after that investment has reached the end of its payback period. It is possible that the investment’s rate of return could subsequently experience a sharp drop, a sharp increase or anything in between. Comparisons of investments’ payback periods, then, will not necessarily yield an accurate portrayal of the profitability of those investments.
Internal rate of return (IRR) is another metric commonly used as an NPV alternative. Calculations of IRR rely on the same formula as NPV does, except with slight adjustments. IRR calculations assume a neutral NPV (a value of zero) and one instead solves for the discount rate. The discount rate of an investment when NPV is zero is the investment’s IRR, essentially representing the projected rate of growth for that investment. Because IRR is necessarily annual – it refers to projected returns on a yearly basis – it allows for the simplified comparison of a wide variety of types and lengths of investments.
For example, IRR could be used to compare the anticipated profitability of a 3year investment with that of a 10year investment because it appears as an annualized figure. If both have an IRR of 18%, then the investments are in certain respects comparable, in spite of the difference in duration. Yet, the same is not true for net present value. Unlike IRR, NPV exists as a single value applying the entirety of a projected investment period. If the investment period is longer than one year, NPV will not account for the rate of earnings in way allowing for easy comparison. Returning to the previous example, the 10year investment could have a higher NPV than will the 3year investment, but this is not necessarily helpful information, as the former is over three times as long as the latter, and there is a substantial amount of investment opportunity in the 7 years' difference between the two investments.
Interested in more information on Net Present Value? See: Time Value of Money: Determining Your Future Worth and our Introduction To Corporate Valuation Methods. For more on the relationship between NPV, IRR and associated terms, see the section of our Guide to Corporate Finance called "Net Present Value and Internal Rate of Return."

Net Present Value Rule
A rule stating that an investment should be accepted if its net ... 
Discounted Payback Period
A capital budgeting procedure used to determine the profitability ... 
Internal Rate Of Return  IRR
A metric used in capital budgeting measuring the profitability ... 
Profitability Index Rule
A regulation for evaluating whether to proceed with a project ... 
Adjusted Present Value  APV
The Net Present Value (NPV) of a project if financed solely by ... 
Capitalization Of Earnings
A method of determining the value of an organization by calculating ...

Professionals
Introduction To Net Present Value And Internal Rate Of Return
These valuation methods will help you make investing decisions. 
Fundamental Analysis
Calculating Net Present Value at Different Points Using Excel
Calculating the net present value (NPV) of your investment projects using Excel. 
Professionals
Net Present Value and the Internal Rate of Return
CFA Level 1  Discounted Cash Flow Applications  Basics 
Investing Basics
Capital Budgeting: Capital Budgeting Decision Tools
Once projects have been identified, management then begins the financial process of determining whether or not the project should be pursued. The three common capital budgeting decision tools ... 
Professionals
The NPV Profile
CFA Level 1  The NPV Profile. Learn how firms can compare projects using an NPV profile graph. Provides a graphical example of how NPV relates to IRR. 
Economics
Capital Budgeting: Which is Better, IRR or NPV?
Using internal rate of return and net present value for capital budgeting evaluations often end in the same result. But there are times when using NPV to discount cash flows makes more sense. 
Professionals
Net Present Value
NPVs reveal exactly how profitable a project will be in comparison to alternatives. 
Investing Basics
Capital Budgeting: The Capital Budgeting Process At Work
This tutorial will conclude with some basic, yet illustrative examples of the capital budgeting process at work. Example 1: Payback PeriodAssume that two gas stations are for sale with the following ... 
Professionals
Net Present Value (NPV) and the Internal Rate of Return (IRR)
CFA Level 1  Net Present Value (NPV) and the Internal Rate of Return (IRR). Learn how to calculate net present value and internal rate of return. Provides samples highlighting the relationship ... 
Personal Finance
An Introduction To Capital Budgeting
We look at three widely used valuation methods and figure out how companies justify spending.

What is the formula for calculating net present value (NPV) in Excel?
Understand how net present value is used to estimate the anticipated profitability of projects or investments and how to ... Read Answer >> 
How do you use net present value to calculate a capital budget?
Learn about the net present value calculation (NPV) and how the NPV rule is used in capital budgeting to compare the expected ... Read Answer >> 
What are the disadvantages of using net present value as an investment criterion?
While net present value (NPV) calculations are useful when you are valuing investment opportunities, the process is by no ... Read Answer >> 
Do you discount working capital in net present value (NPV)?
Learn why changes in net working capital (NPV) should be included in net present value calculations for analyzing a project's ... Read Answer >> 
What is the formula for calculating net present value (NPV)?
Learn about the formula for net present value (NPV) and how this calculation is used in capital budgeting to determine which ... Read Answer >> 
How much debt is too much when calculating capital budgeting?
Learn how companies determine how much debt is acceptable when funding a new project by using the net present value to estimate ... Read Answer >>