Net Present Value - NPV

Dictionary Says

Definition of 'Net Present Value - NPV'


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 an investment or project. 

The following is the formula for calculating NPV:
 

 



Net Present Value (NPV)

 

where:

 



Ct = net cash inflow during the period

Co= initial investment

r = discount rate, and

t = number of time periods 

In addition to the formula, net present value can often be calculated using tables, as well as spreadsheets such as Microsoft Excel.

Investopedia Says

Investopedia explains '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, a dollar earned in the future won’t be worth as much as one earned today. The discount rate in the NPV formula is a way to account for this. Companies have different ways of identifying the discount rate, although a common method is using the expected return of other investment choices with a similar level of risk.

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 into one lump-sum present value amount of, say $565,000. If the owner of the store was willing to sell his business for less than $565,000, the purchasing company would likely accept the offer as it presents a positive NPV investment. Conversely, if the owner would not sell for less than $565,000, the purchaser would not buy the store, as the investment would present a negative NPV at that time and would, therefore, reduce the overall value of the clothing company.

Interested in more information on Net Present Value (NPV)? Check out Time Value of Money: Determining Your Future Worth and our Introduction To Corporate Valuation Methods.

 

Related Video for 'Net Present Value - NPV'

comments powered by Disqus
Hot Definitions
  1. Legal Monopoly

    A company that is operating as a monopoly under a government mandate. A legal monopoly offers a specific product or service at a regulated price and can either be independently run and government regulated, or government run and regulated.
  2. Closed-End Fund

    A closed-end fund is a publicly traded investment company that raises a fixed amount of capital through an initial public offering (IPO). The fund is then structured, listed and traded like a stock on a stock exchange.
  3. Payday Loan

    A type of short-term borrowing where an individual borrows a small amount at a very high rate of interest. The borrower typically writes a post-dated personal check in the amount they wish to borrow plus a fee in exchange for cash.
  4. Securitization

    The process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors.
  5. Economic Forecasting

    The process of attempting to predict the future condition of the economy. This involves the use of statistical models utilizing variables sometimes called indicators.
  6. Chicago Mercantile Exchange - CME

    The world's second-largest exchange for futures and options on futures and the largest in the U.S. Trading involves mostly futures on interest rates, currency, equities, stock indices and agricultural products.
Trading Center