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 over a period of time. NPV is used in capital budgeting to analyze the profitability of a projected investment or project.
The following is the formula for calculating NPV:
Formula used to calculate the Net Present Value (NPV)
In this equation:
Ct = net cash inflow during the period t
Co = 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 profitable, and an investment 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.