Net Present Value (NPV)
Executive Summary
Net Present Value (NPV) is a capital budgeting metric used to calculate the present value of projected cash flows discounted at a target cost of capital or hurdle rate.
Key Takeaways
- time value: NPV discounts future cash flows back to present values using a discount rate.
- investment rule: A positive NPV indicates a project's earnings exceed its costs, adding value to the firm.
- capital budget: NPV is the standard tool for evaluating capital investments and long-term project viability.
Formula
NPV = CF0 + ∑
CFt(1 + r)t
Net Present Value (NPV) Formula
Variable Glossary
| Symbol | Meaning & Description |
|---|---|
| NPV | Net Present Value |
| CF_t | Cash Flow at time period t (negative for outlay, positive for inflow) |
| r | Annual Discount Rate (Hurdle Rate) |
| t | Time Period (Years) |
Step-by-Step Worked Example
1. Mapped Variables
Discount Rate (r)
r8%
Cash Flow Series
CF-10000, 3000, 4200, 6000
2. Equation Substitution
Equation with standard inputs
NPV = -$10,000 + ∑ [CFt ÷ (1 + 0.0800)t]
3. Calculation Steps
Step 1: Identify Initial Investment Outlay (Period 0)
Period 0 cash outlay = -$10,000.
Step 2: Discount Period 1 Cash Flow ($3,000)
PV = $3,000 ÷ (1 + 0.0800)^1 = $2,778.
Step 3: Discount Period 2 Cash Flow ($4,200)
PV = $4,200 ÷ (1 + 0.0800)^2 = $3,601.
Step 4: Discount Period 3 Cash Flow ($6,000)
PV = $6,000 ÷ (1 + 0.0800)^3 = $4,763.
Step 5: Sum Present Values to compute Net Present Value
NPV = $1,141.59.
Final Resolved Net Present Value (NPV)$1,141.59
Live Simulation
NPV Calculator Sandbox
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Annual Discount Rate (%)8%
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Common Mistakes to Avoid
Fixed Discount Rates: Assuming the discount rate is constant over decades is a common mistake. Inflation and market risk changes can impact capital budgeting NPV projections.
Frequently Asked Questions
Interactive Tool
NPV Calculator
Calculate Net Present Value (NPV) for standard cash flow streams.