investing
Net Present Value (NPV)
Net present value (NPV) is the sum of all future cash flows from an investment, discounted back to today's value. A positive NPV means the investment creates value; negative NPV means it destroys value.
Formula
NPV = Σ [Cₜ / (1 + r)ᵗ] − C₀ NPV uses the time value of money to compare investments on equal footing. A return of $1,000 in 10 years is worth less than $1,000 today — NPV quantifies exactly how much less at a given discount rate.
Formula: NPV = Σ [Cₜ / (1+r)ᵗ] − C₀, where Cₜ is the cash flow in period t, r is the discount rate, and C₀ is the initial investment. Used extensively in capital budgeting, real estate analysis, and any multi-year investment decision.
Related terms
- Time Value of Money (TVM)
- The time value of money is the principle that a dollar today is worth more than a dollar in the future because money available now can be invested to earn a return.
- Rate of Return
- A rate of return (RoR) is the net gain or loss of an investment over a specified period, expressed as a percentage of the initial investment.
- Opportunity Cost
- Opportunity cost is the value of the best alternative you give up when making a choice. In finance, it most commonly refers to the return you forgo by keeping money in a low-yield account instead of investing it.
Frequently asked questions
What is Net Present Value (NPV)?
Net present value (NPV) is the sum of all future cash flows from an investment, discounted back to today's value. A positive NPV means the investment creates value; negative NPV means it destroys value.
What is the Net Present Value (NPV) formula?
The formula is: NPV = Σ [Cₜ / (1 + r)ᵗ] − C₀