Net Present Value (NPV)

A Net Present Value (NPV) is a valuation microeconomic economic measure that quantifies the present worth of a series of future cash flows minus the initial investment to assess the profitability of a long-term investment project.

• AKA: Net Present Worth.
• Context:
  • It can typically determine Investment Project Viability through discounted cash flow methodology and time value of money principle.
  • It can typically assess Investment Profitability by comparing the present value of expected future cash inflows to the present value of cash outflows.
  • It can typically support Capital Budgeting Decision by providing a monetary measure of potential investment return.
  • It can typically account for Time Value Difference between current dollars and future dollars through discount rate application.
  • It can typically inform Investment Selection Process by prioritizing positive NPV projects over negative NPV projects.
  • ...
  • It can often facilitate Investment Comparison across different investment opportunities with varying cash flow timing.
  • It can often enable Risk-Adjusted Valuation through different discount rate selections based on investment risk level.
  • It can often incorporate Inflation Effect on future cash flows through real discount rate adjustment.
  • It can often guide Resource Allocation Decisions within capital constraint environment.
  • ...
  • It can range from being a Negative Net Present Value (NPV) to being a Positive Net Present Value (NPV), depending on its investment profitability.
  • It can range from being a Simple Net Present Value (NPV) to being a Complex Net Present Value (NPV), depending on its cash flow pattern complexity.
  • It can range from being an Actual Net Present Value (NPV) to being an Expected Net Present Value (NPV), depending on its certainty level.
  • It can range from being a Short-Term Net Present Value (NPV) to being a Long-Term Net Present Value (NPV), depending on its time horizon.
  • ...
  • It can be calculated by subtracting the present values of cash outflows (including initial investment) from the present values of cash inflows over a time period.
  • It can be referenced during an NPV Analysis that produces an NPV report for investment decision support.
  • It can integrate with Discount Rate Selection process to reflect required rate of return for the investment risk profile.
  • It can work alongside other valuation microeconomic economic measures such as Internal Rate of Return for comprehensive investment assessment.
  • ...
• Examples:
  • NPV Calculation Methods, such as:
    • Standard NPV Formula: [math]\displaystyle{ NPV=\sum^{n}_{t=1}\frac{R_t}{​(1+i)^t} }[/math], where:
      • R_t​ = net cash inflow-outflow during a single period
      • i = discount rate that could be earned in alternative investments
      • t = number of time periods
      • n = total number of time periods
    • Adjusted NPV Calculations, such as:
      • Risk-Adjusted NPV for high-uncertainty project valuation.
      • Inflation-Adjusted NPV for long-term project valuation in inflationary environment.
      • Tax-Adjusted NPV for after-tax project valuation.
  • NPV Applications, such as:
    • Capital Project NPV for manufacturing facility investment.
    • Real Estate NPV for property development project.
    • Corporate Acquisition NPV for business valuation.
    • Research and Development NPV for new product investment.
  • NPV Analysis Tools, such as:
    • NPV Spreadsheet Model for scenario analysis.
    • NPV Financial Calculator for quick investment assessment.
    • NPV Simulation Software for probabilistic outcome evaluation.
  • ...
• Counter-Examples:
  • Return on Investment (ROI) Measure, which calculates percentage return rather than absolute monetary value.
  • Internal Rate of Return, which determines the discount rate that makes NPV equal to zero rather than calculating the present value.
  • Payback Period Measure, which focuses on time to recover investment rather than total value creation.
  • Accounting Rate of Return, which uses accounting profit rather than cash flows and doesn't consider time value of money.
• See: Yield (Finance), Present Value, Time Value of Money, Rate of Return, Discounted Cash Flow, ROI Analysis, Capital Budgeting Technique, Investment Analysis Tool, Valuation Microeconomic Economic Measure.

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References

2022

• (Wikipedia, 2022) ⇒ https://en.wikipedia.org/wiki/Net_present_value Retrieved:2022-1-12.
  • The net present value (NPV) or net present worth (NPW) applies to a series of cash flows occurring at different times. The present value of a cash flow depends on the interval of time between now and the cash flow. It also depends on the discount rate. NPV accounts for the time value of money. It provides a method for evaluating and comparing capital projects or financial products with cash flows spread over time, as in loans, investments, payouts from insurance contracts plus many other applications.

    Time value of money dictates that time affects the value of cash flows. For example, a lender may offer 99 cents for the promise of receiving $1.00 a month from now, but the promise to receive that same dollar 20 years in the future would be worth much less today to that same person (lender), even if the payback in both cases was equally certain. This decrease in the current value of future cash flows is based on a chosen rate of return (or discount rate). If for example there exists a time series of identical cash flows, the cash flow in the present is the most valuable, with each future cash flow becoming less valuable than the previous cash flow. A cash flow today is more valuable than an identical cash flow in the future because a present flow can be invested immediately and begin earning returns, while a future flow cannot.

    NPV is determined by calculating the costs (negative cash flows) and benefits (positive cash flows) for each period of an investment. After the cash flow for each period is calculated, the present value (PV) of each one is achieved by discounting its future value (see Formula) at a periodic rate of return (the rate of return dictated by the market). NPV is the sum of all the discounted future cash flows.

    Because of its simplicity, NPV is a useful tool to determine whether a project or investment will result in a net profit or a loss. A positive NPV results in profit, while a negative NPV results in a loss. The NPV measures the excess or shortfall of cash flows, in present value terms, above the cost of funds. In a theoretical situation of unlimited capital budgeting, a company should pursue every investment with a positive NPV. However, in practical terms a company's capital constraints limit investments to projects with the highest NPV whose cost cash flows, or initial cash investment, do not exceed the company's capital. NPV is a central tool in discounted cash flow (DCF) analysis and is a standard method for using the time value of money to appraise long-term projects. It is widely used throughout economics, financial analysis, and financial accounting.

    In the case when all future cash flows are positive, or incoming (such as the principal and coupon payment of a bond) the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV can be described as the "difference amount" between the sums of discounted cash inflows and cash outflows. It compares the present value of money today to the present value of money in the future, taking inflation and returns into account.

    The NPV of a sequence of cash flows takes as input the cash flows and a discount rate or discount curve and outputs a present value, which is the current fair price. The converse process in discounted cash flow (DCF) analysis takes a sequence of cash flows and a price as input and as output the discount rate, or internal rate of return (IRR) which would yield the given price as NPV. This rate, called the yield, is widely used in bond trading.

    Many computer-based spreadsheet programs have built-in formulae for PV and NPV.

2021

• https://www.investopedia.com/terms/n/npv.asp
  • QUOTE: 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. NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project. NPV is the result of calculations used to find today’s value of a future stream of payments.

    Key Takeaways

    • Net present value, or NPV, is used to calculate the current total value of a future stream of payments.
    • If the NPV of a project or investment is positive, it means that the discounted present value of all future cash flows related to that project or investment will be positive, and therefore attractive.
    • To calculate NPV, you need to estimate future cash flows for each period and determine the correct discount rate.

2020

• http://www.differencebetween.net/business/difference-between-npv-and-roi/#ixzz7HmaX0bU8
  • QUOTE: ... As regards to the NPV, one must consider that this value is not used to ascertain levels of investment. It is simply a number by which the investor is aware of the amount of cash flow that he is receiving as a result of investment. It is also used to measure (or predict) the amount of cash flow that is to come in the future; it does not look at profits and losses in a traditional sense, as it takes into consideration the discount percentage. ...

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