Net Present Value

Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPVx=PresentValueOfInflows−PresentValueOfOutflows. The initial investment is typically negative, so the sum of all future cash flows (inflow minus outflow) must be greater than the initial investment for a project to be accepted.

A company uses NPV when it’s trying to decide whether or not to invest in a project. The idea behind NPV is that a company should invest in a project only if the NPV is positive (meaning that the total present value of all cash inflows from the project is greater than the total present value of all cash outflows).

There are a few different ways to calculate NPV, but the most common method is to discount each future cash flow by an appropriate interest rate and then subtract the initial investment from this sum.

For example, let’s say that a company has an initial investment of $100,000 and expects to receive five annual cash inflows of $50,000 each. The company has determined that an appropriate interest rate for this project is 10%.