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Net Present Value (NPV)

Definition

NPV is the difference between the present value of cash inflows and outflows over a period of time, discounted at a specific rate.

Explanation

NPV is a cornerstone of financial analysis. A positive NPV means the projected earnings exceed the anticipated costs, adjusted for the time value of money. It is considered one of the most reliable methods for evaluating long-term investments because it accounts for risk through the discount rate.

Example

A company evaluates a $1M investment expected to generate $300K annually for 5 years. At a 10% discount rate, the present value of cash flows is $1.137M. NPV = $1.137M - $1M = $137K. Since NPV > 0, the project adds value.

Related Topics

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Internal Rate of Return (IRR)

IRR is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.

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Price-to-Earnings Ratio (P/E)

The P/E ratio measures a company's current share price relative to its earnings per share (EPS).

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