Net Present Value - NPV

AAA

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 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.

 

VIDEO

RELATED TERMS
  1. Present Value - PV

    The current worth of a future sum of money or stream of cash ...
  2. Indicative Net Asset Value - iNAV

    A measure of the intraday net asset value (NAV) of an investment, ...
  3. Discount To Net Asset Value

    A pricing situation that occurs with a closed-end mutual fund ...
  4. NAV Return

    The change in the net asset value of an exchange-traded fund ...
  5. Premium To Net Asset Value

    A pricing situation that occurs when the stock value of a closed-end ...
  6. Discounted Cash Flow - DCF

    A valuation method used to estimate the attractiveness of an ...
Related Articles
  1. Discounted Cash Flow Analysis
    Fundamental Analysis

    Discounted Cash Flow Analysis

  2. Calculating The Present And Future Value ...
    Investing Basics

    Calculating The Present And Future Value ...

  3. Understanding Net Present Value
    Options & Futures

    Understanding Net Present Value

  4. Which is a better measure for capital ...
    Budgeting

    Which is a better measure for capital ...

Hot Definitions
  1. Halloween Strategy

    An investment technique in which an investor sells stocks before May 1 and refrains from reinvesting in the stock market ...
  2. Halloween Massacre

    Canada's decision to tax all income trusts domiciled in Canada. In October 2006, Canada's minister of finance, Jim Flaherty, ...
  3. Zombies

    Companies that continue to operate even though they are insolvent or near bankruptcy. Zombies often become casualties to ...
  4. Witching Hour

    The last hour of stock trading between 3pm (when the bond market closes) and 4pm EST. Witching hour is typically controlled ...
  5. October Effect

    The theory that stocks tend to decline during the month of October. The October effect is considered mainly to be a psychological ...
  6. Repurchase Agreement - Repo

    A form of short-term borrowing for dealers in government securities.
Trading Center