 What
is Net Present Value? Definition
The Net Present Value (NPV) of an investment (project) is the difference
between the sum of the discounted cash flows which are expected from the investment,
and the amount which is initially invested. It is a traditional valuation
method (often for a project) used in the Discounted
Cash Flow measurement methodology, whereby the following steps are undertaken:
Steps in the calculation of Net Present Value
- Calculation of expected free cash
flows (often per per year) that result out of the investment
- Subtract / discount for the cost of capital (an interest rate to adjust
for time and risk)
The intermediate result is called: Present Value.
- Subtract the initial investments
The end result is called: Net Present Value.
Therefore NPV is an amount that expresses how much value an investment
will result in. This is done by measuring all cash flows over time back towards
the current point in present time.
If the NPV method results in a positive amount, the project should be undertaken.
Limitations of Net Present Value
- Although NPV measurement is widely used for making investment decisions,
a disadvantage of NPV is that it does not account for flexibility / uncertainty
after the project decision. See Real
Options for more information.
- Also NPV is unable to deal with intangible benefits. This inability
decreases its usefulness for strategic issues and projects. See
IC Rating for more information.
Book: S. David
Young, Stephen F. O'Byrne - EVA and Value-Based Management: A Practical Guide..
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Book: Aswath Damodaran
- Investment Valuation: Tools and Techniques for Determining the .. -
Book: James R.
Hitchner - Financial Valuation: Applications and Models -
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NPV with a Missing Cash Flow Figure
"Is is possible to calculate NPV with a missing cash flow figure? E.g. the expected cash flows for a 5 year project at 2% with initial investment of £5000 pounds are £1000, £2500, £2300, £1700 and unkn..." |
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Operating Cash Flows
"What is the NPV of a project that has cost of 52,125 and net cash flows of 12,000 per year for 8 years with a cost of capital of 12 percent?" |
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Example of Net Present Calculation
"Consider the following two investments:
Investment 1 requires a cash investment of $ 10,000 today and $14,000 two years from now. One year from now this investment will yield $24,000.
Invest..." |
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NPV of Partial Payments
"Suppose a business sells an average of $ 1000 per month to a group of 200 customers on Net 30 terms. What would be the financial benefit to the seller if those customers each paid 1/30th of the invoi..." |
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NPV assumes Certainty of Cash Flows
"When using the Net Present Value method be careful: this calculation assumes certainly in the forecasted future cash flows. For strategic longer term projects this assumptions is often not valid in to..." |
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Re-evaluating an investment decision
"Question: I am re-evaluating an investment decision from 2004 - - where the initial investment was made. If I wanted to look at the investment today would I need to take the future value of the past C..." |
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Net Present Value (NPV) Special Interest Group
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Compare with Net Present Value: Internal Rate
of Return | Payback
Period | Cost-Benefit
Analysis | Total Cost of Ownership
| CAGR |
Cost of Equity
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