NPV

Net Present Value (NPV) is a financial analysis method used to determine the profitability of an investment or project. It is calculated by subtracting the initial investment from the present value of cash inflows, discounted at a certain discount rate.

Overview

The concept of NPV is rooted in the time value of money principle, which states that a dollar today is worth more than a dollar in the future. This is due to the potential earning capacity of money, which can earn interest over time. Therefore, future cash flows are discounted to reflect their present value.

Calculation

The formula for NPV is:

NPV = ∑ (Ct / (1+r)^t) - C0

Where:

• Ct = net cash inflow during the period t
• r = discount rate
• t = number of time periods
• C0 = initial investment

Interpretation

A positive NPV indicates that the projected earnings (in present dollars) are greater than the anticipated costs, also in present dollars. Therefore, the investment is considered profitable. Conversely, a negative NPV suggests the investment is not profitable. An NPV of zero means the project's earnings are expected to equal its costs.

Limitations

While NPV is a useful tool in capital budgeting, it has its limitations. It assumes that the discount rate remains constant over the life of the project, which may not be the case. It also assumes that all cash flows can be reinvested at the discount rate, which may not be feasible.

See also

• Internal rate of return
• Payback period
• Profitability index

NPV Resources
Latest articles Most recent articles Ongoing trials	Wikipedia