Net Present Value (NPV)

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Traditional valuation method. Explanation of Net Present Value.


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Net Present Value (NPV)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

  1. Calculation of expected free cash flows (often per per year) that result out of the investment
  2. Subtract / discount for the cost of capital (an interest rate to adjust for time and risk)

The intermediate result is called: Present Value.

  1. 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.. -

Book: Aswath Damodaran - Investment Valuation: Tools and Techniques for Determining the .. -

Book: James R. Hitchner - Financial Valuation: Applications and Models -

Net Present Value (NPV) Forum (16 topics) Help
  Calculating Cost per Unit if Zero NPV without any Operating Costs Information  - How does one calculate the cost per unit from the following info?
Initial investment of R120M, R8M maintenance costs per year, R5M additional costs for each 1M units produced and 1.2M units produ...
  NPV for Leased Equipment versus Purchased Equipment  - Do any of you use NPV for a lease situation? I lease equipment and am often asked about purchase versus lease
I do not have the customers cash inflows, but when I'd do this comparison of NPVs, th...
  WHEN to Invest? Investing at the Right Moment...  - I have done a NPV calculation for an investment option. The problem I'm thinking about is not IF I should invest, it is WHEN to invest.
Its weird to make a calculation on a 10 years basis for opt...
  Missed Interest in NPV  - (How) Can I include interest income forgone in an NPV calculation?...      
  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...      
  Calculating NPV with Missing Data  - How will I calculate the NPV if I only have the different annual income for 6 years business proposal?...      
  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?...      
  NPV of $1 Million for a Project Means What  - If a NPV of one project is $1 million, what does it mean to an investor?...      
  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.
  Does the Net Present Value (NPV) calculation uses cash inflows or profits?  - Does the NPV calculation uses cash inflows or profits? Should I use the revenue generated by the project or the profit?...      

See 6 more topics

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