Net Present Value

Finance

Quick Definition

Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.

Detailed Explanation

NPV is a key financial metric used to evaluate investment profitability by considering the time value of money.

It discounts future cash flows to today’s value using a discount rate (usually cost of capital) and compares it with the initial investment.

Formula

👉 NPV = Σ (Cash Inflow / (1 + r)^t) – Initial Investment

Where:

  • r = Discount rate
  • t = Time period

Why NPV Matters

  • Helps in investment decision-making
  • Considers time value of money
  • Measures actual profitability

Interpretation

  • NPV > 0: Investment is profitable (Accept)
  • NPV = 0: Break-even
  • NPV < 0: Investment is not profitable (Reject)

NPV vs IRR

  • NPV: Absolute value of profit
  • IRR: Rate of return

Example

"An investment of ₹1 lakh generates discounted cash inflows of ₹1.2 lakh: 👉 NPV = ₹20,000 → Profitable"

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