{"id":255665,"date":"2024-06-09T08:00:46","date_gmt":"2024-06-09T08:00:46","guid":{"rendered":"https:\/\/www.techopedia.com\/?post_type=definition&#038;p=255665"},"modified":"2024-06-09T08:00:45","modified_gmt":"2024-06-09T08:00:45","slug":"net-present-value-npv","status":"publish","type":"definition","link":"https:\/\/www.techopedia.com\/definition\/net-present-value-npv","title":{"rendered":"Net Present Value (NPV)"},"content":{"rendered":"<h2><span id=\"what_is_net_present_value_npv\">What is Net Present Value (NPV)?<\/span><\/h2>\n<p>Net present value (NPV) is a financial metric used to evaluate the profitability of an investment or project. It represents the difference between the present value of cash inflows and the present value of <a href=\"https:\/\/www.techopedia.com\/definition\/cash-outflow\">cash outflows<\/a> over a period of time.<\/p>\n<p>Putting that into real-world language, we can say it like this:<\/p>\n<p><i>Net present value is how much money we&#8217;ll get back (over time), minus how much we need to spend (today) to make that happen.<\/i><\/p>\n<p>Note: net present value is a single, headline number. If it&#8217;s calculated over a five-year term, a positive NPV could mean that an investment requiring an upfront disbursement of cash today will keep being a drain on your reserves for the next 36 months, only to become profitable after that time. This kind of thing is why it&#8217;s important to read footnotes!<\/p>\n<p><img decoding=\"async\" src=\"https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Net-Present-Value-NPV-300x190.jpg\" alt=\"What is Net Present Value (NPV)?\" width=\"1200\" height=\"760\" class=\"aligncenter wp-image-255668\" srcset=\"https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Net-Present-Value-NPV-300x190.jpg 300w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Net-Present-Value-NPV-1024x649.jpg 1024w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Net-Present-Value-NPV-768x486.jpg 768w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Net-Present-Value-NPV-1536x973.jpg 1536w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Net-Present-Value-NPV-2048x1297.jpg 2048w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Net-Present-Value-NPV-1200x760.jpg 1200w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/2-Net-Present-Value-NPV-1980x1254.jpg 1980w\" sizes=\"(max-width: 1200px) 100vw, 1200px\" \/><\/p>\n<p class=\"p1\"><div class=\"su-note\"  style=\"border-color:#dddddd;border-radius:3px;-moz-border-radius:3px;-webkit-border-radius:3px;\"><div class=\"su-note-inner su-u-clearfix su-u-trim\" style=\"background-color:#F7F7F7;border-color:#ffffff;color:#333333;border-radius:3px;-moz-border-radius:3px;-webkit-border-radius:3px;\">\n<h2><span id=\"key_takeaways\">Key Takeaways<\/span><\/h2>\n<ul>\n<li>Net present value is a financial metric used to evaluate the profitability of an investment or project.<\/li>\n<li>NPV is always expressed as a dollar amount.<\/li>\n<li>Net present value is a summary measure that simplifies complex financial information into a single, understandable figure.<\/li>\n<li>A positive NPV indicates a project is expected to generate more money than it costs, while a negative NPV suggests it will lose money.<\/li>\n<li>NPV is closely related to the Internal Rate of Return (IRR).<\/li>\n<\/ul>\n<p class=\"p1\"><\/div><\/div>\n<h2><span id=\"npvs_importance_in_capital_budgeting\">NPV&#8217;s Importance in Capital Budgeting<\/span><\/h2>\n<p>The future, while not as certain as the present, is at least predictable. This difference between the definite and the expected leads to <a href=\"https:\/\/www.forbes.com\/advisor\/business\/cash-vs-accrual-accounting\/\" target=\"_blank\">two main systems<\/a> of accounting:<\/p>\n<ul>\n<li>In <strong>accrual-basis accounting<\/strong>, all assets, <a href=\"https:\/\/www.techopedia.com\/definition\/liability\">liabilities<\/a>, income, and expenses are treated the same \u2013 according to their nominal value, whenever this may be realized.<\/li>\n<li>Using <strong>cash-basis accounting<\/strong>, by contrast, the only thing that matters is real money coming in and flowing out right now.<\/li>\n<\/ul>\n<p>There needs to be a way to relate one to the other: for example, all companies have both cash flow and income statements, with <a href=\"https:\/\/www.techopedia.com\/definition\/liquid-asset\">liquidity being the conceptual bridge<\/a> between the two.<\/p>\n<p>For capital budgeting purposes, the equivalent of liquidity is net present value.<\/p>\n<h2><span id=\"what_npv_tells_you\">What NPV Tells You<\/span><\/h2>\n<p>One important thing you may have noticed from our definition of net present value is that it&#8217;s always expressed as a dollar amount. It&#8217;s not a percentage \u2013 and those dollars are each worth the same amount.<\/p>\n<h3>NPV Formula<\/h3>\n<p>Even if Greek letters give you the heebie-jeebies, the net present value is a cinch to calculate if you have all the needed data:<\/p>\n<p><img decoding=\"async\" src=\"https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-NPV-Formula-300x203.jpg\" alt=\"NPV Formula\" width=\"1200\" height=\"810\" class=\"aligncenter wp-image-255669\" srcset=\"https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-NPV-Formula-300x203.jpg 300w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-NPV-Formula-1024x691.jpg 1024w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-NPV-Formula-768x518.jpg 768w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-NPV-Formula-1536x1037.jpg 1536w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-NPV-Formula-2048x1382.jpg 2048w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-NPV-Formula-1200x810.jpg 1200w, https:\/\/www.techopedia.com\/wp-content\/uploads\/2024\/06\/3-NPV-Formula-1980x1337.jpg 1980w\" sizes=\"(max-width: 1200px) 100vw, 1200px\" \/><\/p>\n<h4>How to Calculate NPV<\/h4>\n<p>Technically, the net present value calculation is a time series: to get the answer, you need to know or estimate the cash flow for each period. When determining NPV, these intervals may be months, quarters, or even years.<\/p>\n<h2><span id=\"components_of_npv\">Components of NPV<\/span><\/h2>\n<p>When using the net present value formula, you have to make sure that the value you assign to each of these variables is reasonable, justifiable, and as accurate as the situation permits.<\/p>\n<p>The letter &#8220;<strong><i>n<\/i><\/strong>&#8220;, wherever it appears, corresponds to the first, second, etc. time period \u2013 the one you&#8217;re crunching the numbers on.<\/p>\n<p><strong><i>T<\/i><\/strong> refers to the number of periods. If the scope of the investment or project is one year and NPV is calculated on a monthly basis, <i>T<\/i> will be equal to 12.<\/p>\n<p><strong><i>C<\/i><\/strong><strong><i>n<\/i><\/strong>, simply means the total cash flow during the period denoted by <strong><i>n<\/i><\/strong>. This may be positive or negative and will normally vary over time.<\/p>\n<p><strong><i>C<\/i><\/strong><strong><i>0<\/i><\/strong> is the upfront cost \u2013 the amount of money paid out before the first period in which we see ordinary cash flow.<\/p>\n<p><strong><i>r<\/i><\/strong> is the expected (or required) discount rate. Investors often use inflation as a kind of first approximation for <strong><i>r<\/i><\/strong>.<\/p>\n<h2><span id=\"positive_npv_vs_negative_npv\">Positive NPV vs. Negative NPV<\/span><\/h2>\n<p>Net present value is an example of what a statistician would call a &#8220;summary measure&#8221;, like an average. Though a lot of information goes into calculating it, the result is a single, bottom-line number that enables managers and investors to determine, at a glance, whether an idea is good or bad. If &#8220;good&#8221;, they will presumably spend some time delving into the details.<\/p>\n<p class=\"p1\"><div class=\"su-accordion su-u-trim\">\n<p class=\"p1\"><div class=\"su-spoiler su-spoiler-style-fancy su-spoiler-icon-plus\" data-scroll-offset=\"0\" data-anchor-in-url=\"no\"><div class=\"su-spoiler-title\" tabindex=\"0\" role=\"button\"><span class=\"su-spoiler-icon\"><\/span><strong>Positive NPV<\/strong><\/div><div class=\"su-spoiler-content su-u-clearfix su-u-trim\"> Implies that a project is worth funding: it will bring in more money than it costs \u2013 <i>in today&#8217;s dollars<\/i>. <\/div><\/div>\n<p class=\"p1\"><div class=\"su-spoiler su-spoiler-style-fancy su-spoiler-icon-plus su-spoiler-closed\" data-scroll-offset=\"0\" data-anchor-in-url=\"no\"><div class=\"su-spoiler-title\" tabindex=\"0\" role=\"button\"><span class=\"su-spoiler-icon\"><\/span><strong>Negative NPV<\/strong><\/div><div class=\"su-spoiler-content su-u-clearfix su-u-trim\">\n<p>Indicates the opposite: when <a href=\"https:\/\/www.techopedia.com\/definition\/inflation\">inflation<\/a> is taken into account, the investment is expected to lose money in real terms.<\/p>\n<p>Especially in a business context, the <a href=\"https:\/\/corporatefinanceinstitute.com\/resources\/valuation\/time-value-of-money\/\" target=\"_blank\">time value of money<\/a> requires a lot more effort to calculate.<\/p>\n<p class=\"p1\"><\/div><\/div>\n<p class=\"p1\"><\/div>\n<h2><span id=\"npv_vs_internal_rate_of_return_irr\">NPV vs. Internal Rate of Return (IRR)<\/span><\/h2>\n<p>You will often hear about another accounting concept closely related to NPV, called <a href=\"https:\/\/www.techopedia.com\/definition\/internal-rate-of-return-irr\">internal rate of return<\/a> (IRR). Both give a more accurate picture of a capital investment&#8217;s attractiveness than a simple <a href=\"https:\/\/www.techopedia.com\/definition\/return-on-investment-roi\">return on investment<\/a> (ROI), which doesn&#8217;t explicitly account for the fact that next year&#8217;s dollars are worth less than this year&#8217;s.<\/p>\n<p>IRR, however, turns the equation we&#8217;ve just encountered on its head by assuming a zero return. This just means using nothing for net present value and solving for <strong><i>r<\/i><\/strong>, the discount rate, instead.<\/p>\n<p>In other words, IRR answers the question: &#8220;How much does the investment have to yield to just break even when adjusting for inflation (or, more generally, the future value of money)?&#8221; It is expressed as a percentage.<\/p>\n<h2><span id=\"npv_example\">NPV Example<\/span><\/h2>\n<p>Net present value is often used as a primary cost\/benefit analysis tool within companies. If we spend <i>x<\/i> today, will we come out ahead in due time?<\/p>\n<p>Bob is considering buying an apartment using a personal loan to finance <strong>$100,000<\/strong> of the purchase price. He will rent it out for <strong>10 years<\/strong> and, once the outstanding loan balance has been repaid, expects to clear <strong>$20,000<\/strong> in capital gains.<\/p>\n<p>Ignoring all kinds of expenses:<\/p>\n<p>Loan payments &#8211; 1,000<\/p>\n<p>Maintenance &#8211; 200<\/p>\n<p>Rent &#8211; 1,100<\/p>\n<p>As these figures are monthly, we have:<\/p>\n<p><strong><i>T<\/i><\/strong> = 120, <strong><i>C<\/i><\/strong><strong><i>o<\/i><\/strong> = 100,000, <strong><i>C<\/i><\/strong><strong><i>n<\/i><\/strong> = (1,100 \u2013 1,200) = -100 (assumed to be the same during every period except the last, when the property is sold, yielding <strong><i>C<\/i><\/strong><strong><i>120<\/i><\/strong> = 120,000 \u2013 100).<\/p>\n<p>For the discount rate <strong><i>r<\/i><\/strong>, let&#8217;s just use a CPI figure of 3.5%.<\/p>\n<p>This equals an NPV of about negative $25,000.<\/p>\n<p>This makes sense: the value of the initial $100,000 outlay, the $20,000 profit at the end of 10 years, and the $12,000 in negative cash flow in the meantime <i>aren&#8217;t measured in the same dollars!<\/i><\/p>\n<h2><span id=\"npv_pros_and_cons\">NPV Pros and Cons<\/span><\/h2>\n<p>One drawback of looking only at a project&#8217;s net present value is that it doesn&#8217;t give you the whole cash flow picture. Potentially, you may have to keep on shelling out cash well into the future just to sustain the project or investment (a small, growing business, for instance). This doesn&#8217;t impact a company like General Electric or Blackrock all that much, but may mean a great deal to a small, independent investor.<\/p>\n<p>On the positive side, the very definition of NPV emphasizes the word <i>present<\/i>. Let&#8217;s use a five-year horizon and allow the specter of inflation into our minds: at 3.5% CPI and assuming you get your money back without any net loss or profit, the buck you invest today only comes to 86.7 cents.<\/p>\n<h2><span id=\"the_bottom_line\">The Bottom Line<\/span><\/h2>\n<p>We all know that money loses value over time; investors use discount rates (inflation or otherwise) every day. Getting a gut feel for how this works is, however, difficult. The concept of net present value, stated as it is in dollars and cents, makes it easy to think about longer timeframes. It does not, however, make any provision for unforeseen events or bad data.<\/p>\n<h2><span id=\"faqs\">FAQs<\/span><\/h2>\n<div class=\"man_faq_sec\" itemscope itemtype=\"https:\/\/schema.org\/FAQPage\"><\/time><section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">What is net present value in simple terms?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">Let&#8217;s say we&#8217;re planning something that&#8217;s going to cost money upfront as well as bringing in or sucking out money over time. NPV is just a way to calculate the total return using today&#8217;s value of money.<\/p>\r\n                <\/div><\/div><\/section>\n<section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">How to calculate the NPV?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">Using the formula \u03a3[(cash inflow)\/(1+discount rate)n \u2013 initial outlay] gives you the overall return in annualized dollars; precisely what the net present value is.<\/p>\r\n                <\/div><\/div><\/section>\n<section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">Is net present value the same as profit?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">Profit, expressed in simple monetary terms, does not take into account that the value of money drops over time. NPV does consider this factor, making it a more valuable performance indicator especially over long timeframes.<\/p>\r\n                <\/div><\/div><\/section>\n<section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">Why is NPV important?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">The net present value matters because it can tell managers and investors, at a glance, whether undertaking a project or buying an asset is worth the cost \u2013 especially when to compared with other, similar alternatives.<\/p>\r\n                <\/div><\/div><\/section>\n<section class=\"ms_faq ms_card \" ><div itemscope itemprop=\"mainEntity\" itemtype=\"https:\/\/schema.org\/Question\"><div class=\"accordionButton\"><h3 itemprop=\"name\">What is a Good NPV?<\/h3> <\/div>\n<div class=\"accordionContent\" itemscope itemprop=\"acceptedAnswer\" itemtype=\"https:\/\/schema.org\/Answer\" style=\"display:none;\"><p itemprop=\"text\">Any net present value of over zero can be considered &#8220;good&#8221;. In the real world, however, there may be several alternative ways to invest your money, each with its own NPV (and its own set of risks, which this figure doesn&#8217;t reflect!).<\/p>\r\n                <\/div><\/div><\/section>\n<div class=\"reference-content\">\n<div class=\"reference-heading reference-content-collapsible-heading\">\n<h2><span id=\"references\">References<\/span><\/h2>\n<\/div>\n<div class=\"reference-content-body\">\n<ol>\n<li><a href=\"https:\/\/www.forbes.com\/advisor\/business\/cash-vs-accrual-accounting\/\" target=\"_blank\">Cash Vs. Accrual Accounting: What&#8217;s The Difference?<\/a> (Forbes)<\/li>\n<li><a href=\"https:\/\/corporatefinanceinstitute.com\/resources\/valuation\/time-value-of-money\/\" target=\"_blank\">Time Value of Money<\/a> (Corporatefinanceinstitute)<\/li>\n<\/ol>\n<\/div>\n<\/div>\n<\/div>","protected":false},"excerpt":{"rendered":"<p>What is Net Present Value (NPV)? Net present value (NPV) is a financial metric used to evaluate the profitability of an investment or project. It represents the difference between the present value of cash inflows and the present value of cash outflows over a period of time. Putting that into real-world language, we can say [&hellip;]<\/p>\n","protected":false},"author":286908,"featured_media":255667,"comment_status":"open","ping_status":"closed","template":"","format":"standard","meta":{"_acf_changed":false,"_lmt_disableupdate":"","_lmt_disable":"","om_disable_all_campaigns":false,"footnotes":""},"definitioncat":[2686],"class_list":["post-255665","definition","type-definition","status-publish","format-standard","has-post-thumbnail","hentry","definitioncat-economics"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v24.2 (Yoast SEO v24.5) - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>What is Net Present Value? 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