Brief Definition
Net present value (NPV) is a financial measure used to compare the present value of expected cash inflows to the present value of expected cash outflows for an investment or project. It considers the time value of money, meaning that a dollar received in the future is worth less than a dollar received today. If the net present value is positive, it means the investment is expected to be profitable, while a negative net present value indicates that it’s not profitable. NPV is an important tool for evaluating investment projects.
Further Explanation
Net present value (NPV) is a term used in finance and investing to evaluate the value of an investment or project by comparing the present value of its expected cash inflows to the present value of its expected cash outflows. It takes into account the time value of money, which means that a dollar received in the future is worth less than a dollar received today, due to inflation and the opportunity cost of waiting.
In other words, net present value is the difference between the present value of a project’s expected cash inflows and the present value of its expected cash outflows. If the net present value is positive, it indicates that the project is expected to generate more cash inflows than outflows and is therefore considered a profitable investment. If the net present value is negative, it indicates that the project is expected to generate less cash inflows than outflows and is therefore considered unprofitable.
To calculate net present value, the expected cash inflows and outflows are first estimated for each year of the project’s life. These are then discounted to their present value using a discount rate, which reflects the time value of money and the risk associated with the investment. The present value of the cash inflows is then subtracted from the present value of the cash outflows to determine the net present value.
Net present value is an important tool for evaluating the profitability and feasibility of investment projects, and is widely used in corporate finance, capital budgeting, and investment analysis.