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Net present value answers the fundamental investment question: is this worth doing? It converts all of a project's future cash flows into today's money — because a dollar next year is worth less than a dollar now — and subtracts the upfront cost. A positive NPV means the investment creates value; a negative one means it destroys it.
Enter the initial investment, a discount rate and the yearly cash flows, and the NPV plus a clear verdict appear at once.
How is it calculated?
The idea: money has a time value
A payment received in the future is worth less than the same amount today, because today's money can be invested. NPV discounts each future cash flow back to the present:
NPV = −initial + Σ [cash flowₜ ÷ (1 + r)ᵗ]
where r is the discount rate and t the year. It sums today's value of every future inflow, then subtracts the initial outlay.
The discount rate
The discount rate reflects your required return or cost of capital — the return you could earn elsewhere at similar risk. A higher rate discounts the future more heavily, lowering NPV. Choosing it is the most consequential (and subjective) input: too low overvalues distant cash flows, too high rejects good projects.
Reading the result
- NPV > 0: the project returns more than your discount rate demands — it creates value.
- NPV < 0: it returns less — it destroys value at that rate.
- NPV = 0: it exactly meets your required return (this rate is the IRR).
Where it helps
- Deciding whether to make an investment or take on a project
- Comparing projects with different cash-flow timings
- Valuing a stream of future income in today's terms
The rate that makes NPV zero is the internal rate of return — find it with an IRR calculator.
Worked example
Invest 100,000 upfront in a project that returns 45,000 at the end of each of the next three years, and use a 10% discount rate. Each inflow is discounted: 45,000 ÷ 1.10 = 40,909, 45,000 ÷ 1.21 = 37,190, 45,000 ÷ 1.331 = 33,809. Their total present value is 111,908, minus the 100,000 cost gives an NPV of +11,908. Because it's positive, the project earns more than 10% and creates value. Note the timing effect: the raw cash in is 135,000, but discounting shrinks it to 111,908 — that erosion is exactly the time value of money the NPV captures.
FAQ
How is NPV calculated?+
Each future cash flow is discounted to today with ÷ (1 + rate)^year, summed, and the initial investment subtracted. For 100,000 in and 45,000 × 3 years at 10%, NPV is +11,908.
What does a positive or negative NPV mean?+
Positive NPV means the investment returns more than your discount rate requires — it creates value. Negative means it returns less and destroys value. Zero means it exactly meets your required return.
What is the discount rate and how do I choose it?+
It's your required return or cost of capital — what you could earn elsewhere at similar risk. Higher rates discount future cash more heavily. It's the most influential and subjective input.
Why is future money worth less than money today?+
Because today's money can be invested to grow. A payment a year away is worth less than the same amount now, so NPV discounts each future flow back to present value before comparing.
How does NPV relate to IRR?+
IRR is the discount rate at which NPV equals zero. If your discount rate is below the IRR, NPV is positive; above it, negative. Find the IRR with an IRR calculator.
Can I compare two projects with NPV?+
Yes — at the same discount rate, the project with the higher NPV creates more value. NPV is especially useful when projects have differently timed cash flows.