Net Present Value (NPV) Calculator
Future Cash Flows (Net Income per Year)
Net Present Value (NPV)
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What is Net Present Value (NPV)?
Net Present Value (NPV) is a financial metric used to evaluate the profitability of an investment or project. It represents the difference between the present value of cash inflows and the present value of cash outflows over a period of time.
The core concept behind NPV is the "Time Value of Money," which dictates that a dollar today is worth more than a dollar in the future due to its potential earning capacity (interest or investment returns).
The Role of the Discount Rate
The Discount Rate is the critical percentage used to discount future cash flows back to their present value. It typically represents:
- The cost of capital (how much it costs to borrow the money).
- The required rate of return set by investors.
- The opportunity cost of investing in this project versus another with similar risk.
A higher discount rate lowers the present value of future cash flows, making long-term projects harder to justify.
NPV Formula
The standard formula used in this calculator is:
NPV = [ CF1 / (1+r)^1 + CF2 / (1+r)^2 + … + CFn / (1+r)^n ] – Initial Investment
Where:
- CF = Cash Flow in a specific year
- r = Discount Rate (decimal)
- n = Number of the year
Interpreting the Result
- Positive NPV (> 0): The projected earnings (in today's dollars) exceed the anticipated costs. The investment is generally considered profitable.
- Negative NPV (< 0): The costs exceed the projected earnings. The investment will likely result in a net loss.
- Zero NPV (= 0): The investment is expected to break even exactly.
Example Calculation
Imagine investing $10,000 today in a project that returns $3,000 per year for 5 years. If your required discount rate is 10%:
- Year 1 PV: $3,000 / 1.10 = $2,727.27
- Year 2 PV: $3,000 / 1.21 = $2,479.34
- Year 3 PV: $3,000 / 1.331 = $2,253.94
- Year 4 PV: $3,000 / 1.4641 = $2,049.04
- Year 5 PV: $3,000 / 1.6105 = $1,862.76
- Total PV of Inflows: $11,372.35
- Less Initial Investment: $10,000.00
- NPV: $1,372.35
Since the NPV is positive ($1,372.35), the project is financially attractive at a 10% discount rate.