What is Net Present Value (NPV)?
Today value of a project future cash flows, minus what it costs - the core rule for investment decisions.
Net Present Value (NPV): definition
NPV applies the time value of money: a dollar next year is worth less than a dollar today, so future cash flows are discounted back at a rate reflecting risk and the cost of capital. If the discounted inflows exceed the outflows, NPV is positive and the project earns more than the required return. It is the most theoretically sound capital-budgeting rule.
Net present value
NPV = Σ [ Cash Flow_t ÷ (1 + r)^t ] − Initial Investment
r is the discount rate (often WACC); t is the period. Accept projects with NPV > 0; when ranking, prefer higher NPV.
How Fintra handles it
Fintra planning can project a decision cash flows on the same data model as the actuals, then discount them to an NPV using a rate you set. Because the assumptions live in the plan, you can flex the discount rate or cash timing and watch NPV respond, and compare NPV against IRR and payback in one place.
- Projected cash flows discounted to NPV at a chosen rate
- Sensitivity on discount rate and timing shows how robust the decision is
- NPV shown next to IRR and payback for the same project
Worked example
| Year | Cash flow | Discount factor | Present value |
|---|---|---|---|
| 0 | −$100,000 | 1.000 | −$100,000 |
| 1 | $40,000 | 0.909 | $36,360 |
| 2 | $45,000 | 0.826 | $37,170 |
| 3 | $50,000 | 0.751 | $37,550 |
| NPV | - | - | $11,080 |
Frequently asked questions
What does a positive NPV mean?
It means the project is expected to return more than the discount rate requires, adding value beyond the cost of capital. A negative NPV means the project destroys value at that rate. Zero NPV means it exactly meets the required return.
What discount rate should I use for NPV?
Commonly the weighted average cost of capital (WACC), adjusted up for riskier projects. A higher rate discounts future cash flows more heavily, lowering NPV. Because the rate strongly affects the result, test a range rather than a single number.
What is the difference between NPV and IRR?
NPV gives a dollar value of created wealth at a chosen rate; IRR gives the rate at which NPV equals zero. NPV is generally preferred for ranking projects because IRR can mislead with unconventional cash flows or when comparing different project sizes.
Does NPV account for risk?
Indirectly, through the discount rate - riskier projects use higher rates, which lowers NPV. NPV does not model uncertainty on its own, so pair it with sensitivity or scenario analysis, which Fintra supports, to see the range of outcomes.
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