What is Net Present Value (NPV)?
Net present value (NPV) is the core capital budgeting metric: it compares the present value of an investment's future cash inflows to its upfront cost. A positive NPV means a project is expected to add value; a negative NPV means it destroys value.
NPV is the sum of the present values of all expected cash inflows from a project, minus the initial investment. For a project with equal annual cash flows, NPV = CF × [1 − (1+r)^−n] / r − C₀.
Try it: interactive calculator
Step-by-step worked examples
A project costs $100,000 today and returns $25,000 per year for 6 years. At a 10% discount rate, what is its NPV?
Annuity factor = [1-(1.10)^-6]/0.10 = 4.3553 PV of inflows = 25,000 × 4.3553 = $108,881.50 NPV = 108,881.50 − 100,000 = $8,881.50
A machine costs $50,000 and generates $8,000/year for 10 years at a 6% discount rate. Find NPV.
Annuity factor = [1-(1.06)^-10]/0.06 = 7.3601 PV of inflows = 8,000 × 7.3601 = $58,880.60 NPV = 58,880.60 − 50,000 = $8,880.60
An expansion costs $200,000 and yields $30,000/year for 12 years at an 8% discount rate.
Annuity factor = [1-(1.08)^-12]/0.08 = 7.5361 PV of inflows = 30,000 × 7.5361 = $226,082.40 NPV = 226,082.40 − 200,000 = $26,082.40
Flashcards
Quick quiz
Q1.A project has NPV = $8,881.50. What should the company do?
Q2.What does a negative NPV indicate?
Q3.In the NPV formula, why do we discount future cash flows?
Q4.If the discount rate increases, NPV typically…
The full card deck, worked steps and AI-tutor support for “What is Net Present Value (NPV)?” are in Notek — study by hand before your exam.
Common mistakes
Ignoring the initial investment when calculating NPV. — Correct: Always subtract the upfront cost (C₀) from the present value of inflows.
Comparing projects using total cash flow instead of NPV. — Correct: Total cash flow ignores timing — NPV correctly discounts each period.
Using the wrong discount rate (e.g., a random guess). — Correct: Use the company's cost of capital or required rate of return.
Assuming a positive NPV guarantees success. — Correct: NPV depends on cash flow estimates — inaccurate forecasts still carry risk.
FAQ
What is net present value?
NPV is the present value of a project's future cash inflows minus its initial cost — a measure of the value it's expected to create.
What is the NPV formula?
NPV = Σ [CFₜ/(1+r)^t] − C₀; for equal annual cash flows, NPV = CF×[1−(1+r)^−n]/r − C₀.
How do you calculate NPV?
Discount each future cash flow to its present value, sum them, then subtract the initial investment.
What are examples of NPV in practice?
Deciding whether to buy new equipment, launch a product, or invest in a real estate project based on expected cash flows.