Net Present Value (NPV) Calculator
How to Calculate Net Present Value with Discount Rate
Understanding the value of future money today is a cornerstone of financial analysis. This Net Present Value (NPV) calculator helps investors and business managers determine the profitability of an investment by discounting future cash flows back to their present value using a specific discount rate.
What is Net Present Value (NPV)?
Net Present Value is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. It is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.
The core concept is the Time Value of Money: a dollar earned in the future is worth less than a dollar owned today due to inflation and opportunity costs (the ability to earn interest on money held today).
The NPV Formula
To calculate NPV manually, you sum the discounted cash flows for each period and subtract the initial investment:
NPV = Σ [Rt / (1 + i)^t] – Initial Investment
- Rt: Net cash inflow-outflows during a single period t.
- i: Discount rate or return that could be earned in alternative investments.
- t: Number of time periods.
Understanding the Discount Rate
The Discount Rate is the most critical variable in the NPV calculation. It represents the minimum rate of return required to justify the investment. Common benchmarks for the discount rate include:
- Weighted Average Cost of Capital (WACC): For corporate projects.
- Risk-Free Rate + Risk Premium: For adjusting based on investment volatility.
- Target Return: An investor's personal hurdle rate.
A higher discount rate reduces the present value of future cash flows, making it harder for a project to show a positive NPV.
Interpreting the Result
The result of the calculation tells you whether the investment adds value:
- Positive NPV (> $0): The projected earnings (in today's dollars) exceed the anticipated costs. The investment is generally considered good.
- Negative NPV (< $0): The project is expected to result in a net loss relative to the initial investment and the required rate of return. The investment should likely be rejected.
- Zero NPV: The project is expected to break even exactly at the given discount rate.
Example Calculation
Imagine you invest $10,000 today (Initial Investment) in a project that will return $3,000 at the end of Year 1, $4,000 at Year 2, and $5,000 at Year 3. You require a 10% return (Discount Rate).
Using the calculator above:
- Year 1 PV: $3,000 / (1.10)^1 = $2,727.27
- Year 2 PV: $4,000 / (1.10)^2 = $3,305.79
- Year 3 PV: $5,000 / (1.10)^3 = $3,756.57
- Total PV of Cash Flows: $9,789.63
- NPV: $9,789.63 – $10,000 = -$210.37
In this scenario, despite receiving $12,000 in total cash over 3 years, the project destroys value because the money arrives too late relative to the 10% discount rate.