Net Present Value (NPV)

Net Present Value (NPV)

Net Present Value is the measure of potential increase/ decrease in the company’s or investors’ wealth as a result of undertaking any project. It is calculated as the sum of the present value of all project-related cash inflow, outflows, and initial investment. In order to calculate NPV we need the following information:

  • All project-related cash flows (initial investment, residual value, income, expenses, etc.)
  • Timeline of above cash flows
  • Discount rate (also called the cost of capital i.e. the rate at which investor will be able to raise funds for the project)

Example:

A company is considering initiating a 5-year project. The project requires an initial investment of $ 5,000,000 and thereafter annual cash outflows of $ 800,000 to run operations. Expected revenue from the project is $ 2,500,000 for years 1 and 2 while $ 2,000,000 per year from year 3 onwards. The cost of capital is 10%. Assume that operational outflows and revenues will be received at the end of the respective year.

Net Present Value (NPV)

One thought on “Net Present Value (NPV)”

  1. Great article. Good to understand for everyone.

Related Post