Net present value

NPV = Sum of discounted cash flows - initial investment

Net present value (NPV) is a financial metric used to evaluate the profitability of an investment by comparing the present value of future cash flows to the initial cost. NPV accounts for the time value of money, acknowledging that a dollar today is worth more than a dollar in the future due to factors like interest rates and inflation. This method helps investors and businesses decide whether a project or investment will yield a positive return, indicating financial viability.

Example

If an investment requires an initial outlay of $100,000 and is expected to generate $30,000 annually for 5 years, with a discount rate of 10%, the NPV calculation would involve discounting each $30,000 cash flow to its present value and summing them up before subtracting the initial investment. The result would indicate whether the investment is financially worthwhile.

Understanding NPV is crucial for making informed investment decisions, as it helps determine the potential profitability and financial viability of projects.

Related concepts

Internal rate of return

IRR is the discount rate making NPV zero

Net worth

Net worth = Total assets - Total liabilities

Beta (finance)

Beta measures a stock's volatility relative to the market

Value at risk

Value at Risk (VaR) estimates potential loss under normal market conditions

Graham's net-net strategy is

Graham's net-net strategy: Buy stocks trading below net current asset value

Treynor ratio

Treynor ratio measures excess return per unit of systematic risk

Educational content, not financial advice.

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