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.
VIDEO
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 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.
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."

Discounted Cash Flow (DCF)
Discounted cash flow (DCF) is a valuation method used to estimate ... 
Current Ratio
The current ratio is a liquidity ratio measuring a company's ... 
Debt/Equity Ratio
Debt/Equity Ratio is debt ratio used to measure a company's financial ... 
PriceEarnings Ratio  P/E Ratio
The PricetoEarnings Ratio or P/E ratio is a ratio for valuing ... 
Internal Rate Of Return  IRR
A metric used in capital budgeting measuring the profitability ... 
PeerToPeer (Virtual Currency)
The exchange or sharing of information, data, or assets between ...

Markets
Operating Cash Flow: Better Than Net Income?
Differences between accrual accounting and cash flows show why net income is easier to manipulate. 
Investing
Days Payable Outstanding
Days Payable Outstanding, or DPO, is an accounting measurement that tells the average number of days it takes a company to pay its suppliers and vendors. Days Payable Outstanding is widely used ... 
Investing
Net Operating Income
Net operating income (NOI) reflects income after operating expenses are deducted, but before income taxes and interest are deducted. 
Investing Basics
Liquidity Vs. Solvency
Learn about the differences between these two words and how each one is used in the stock market. 
Investing Basics
Liquid & Illiquid Assets
The easier it is to convert the asset, the more liquid the asset is considered. 
Investing Basics
Current Assets
Current assets are all of the assets a company uses to fund its daily operations. These are the assets the company could convert into cash within a year in the normal course of business. 
Investing
Zooming In On Net Operating Income
NOI is a longrun profitability measure that smart investors can count on. 
Fundamental Analysis
Valuing Firms Using Present Value Of Free Cash Flows
When trying to evaluate a company, it always comes down to determining the value of the free cash flows and discounting them to today. 
Personal Finance
Assets That Increase Your Net Worth
Your home, properties and vehicles can all increase your net worth. 
Investing
The Importance Of Knowing Your Net Worth
It is vital that you track your net worth no matter what your age.

Do you include working capital in net present value (NPV)?
Working capital is included in calculating the net present value (NPV) of a company. NPV is the difference between the present ... Read Full Answer >> 
When evaluating terminal value, should I use the perpetuity growth model or the exit ...
In discounted cash flow (DCF) analysis, neither the perpetuity growth model nor the exit multiple approach is likely to render ... Read Full Answer >> 
What is the relationship between the hurdle rate (MARR) and the Internal Rate of ...
In capital budgeting, projects are often evaluated by comparing the internal rate of return, or IRR, on a project to the ... Read Full Answer >> 
What is the formula for calculating the internal rate of return (IRR)?
Computing the internal rate of return (IRR) for a possible investment is timeconsuming and inexact. IRR calculations must ... Read Full Answer >> 
What is the formula for calculating net present value (NPV)?
Net present value (NPV) is a method of determining the current value of all future cash flows generated by a project after ... Read Full Answer >> 
What is the formula for calculating internal rate of return (IRR) in Excel?
The internal rate of return (IRR), is a profitability metric used by businesses to determine which projects are likely to ... Read Full Answer >> 
What is the formula for calculating net present value (NPV) in Excel?
Net present value (NPV) is a popular measure of profitability used in corporate budgeting to assess a given project's potential ... Read Full Answer >> 
Why would you take DCF into account rather than simply projecting future revenues?
Discounted cash flow, or DCF, analysis is preferred by market analysts for two basic reasons. One, because of the firmly ... Read Full Answer >> 
How do you use DCF for real estate valuation?
Discounted cash flow analysis, or DCF, is very commonly used in evaluation of real estate investments, although determining ... Read Full Answer >> 
What are the difference between gross revenue reporting and net revenue reporting?
Recognizing and reporting revenue are critical and complex problems for accountants. There are many gray areas in both recognition ... Read Full Answer >> 
What are the differences between gross profit and net income?
When preparing either an income statement or an income tax return for a business, accountants provide calculations for both ... Read Full Answer >> 
Which of the following is not needed to calculate the net present value of an investment?
A. The amount of interest expected to be generated each yearB. The time horizon – how long the investment is expected to ... Read Full Answer >> 
Under the Investment Company Act of 1940, an investment company must have minimum ...
A. $25,000B. $50,000C. $100,000D. $500,000 Correct answer: CAn investment company (mutual fund) must have ... Read Full Answer >> 
Under the Investment Company Act of 1940, an investment company, or mutual fund company, ...
A. $25,000B. $50,000C. $100,000D. $500,000 Correct answer: CAn investment company (mutual fund) must have at least ... Read Full 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 Full Answer >> 
What are the advantages and disadvantages to dealing with internetonly banks?
In recent years, large companies have set up internetonly banks as a means of diversifying into the financial sector and ... Read Full Answer >> 
Is it possible for a company to have a positive cash flow and a negative net income?
This situation may seem a bit counterintuitive at first, but it is actually quite common and not too difficult to understand. ... Read Full Answer >> 
What's the difference between net present value and internal rate of return? How ...
Both of these measurements are primarily used in capital budgeting, the process by which companies determine whether a new ... Read Full Answer >> 
Why do some closedend mutual funds trade above or below their net asset values?
Intuition tells us that a mutual fund's net asset value (NAV) (the net value of all assets within the mutual fund's portfolio ... Read Full Answer >> 
Which is a better measure for capital budgeting, IRR or NPV?
In capital budgeting, there are a number of different approaches that can be used to evaluate any given project, and each ... Read Full Answer >>