What Does Net Present Value (NPV) Mean?
The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. NPV analysis is sensitive to the reliability of future cash inflows that an investment or project may yield. It is calculated as shown here:
Investopedia explains Net Present Value (NPV)
NPV compares the value of a dollar today to the value of that dollar at a future point, taking inflation and returns into account. If the NPV of a prospective project is positive, the project should be accepted. However, if NPV is negative, the project probably should be rejected because cash flows will be negative. For example, if a retail clothing business wants to purchase an existing store, it will estimate the future cash flows of the store and then discount those cash flows into one lump-sum present value amount, say, $565,000. If the owner of the store is willing to sell the business for less than $565,000, the purchasing company probably will accept the offer because it is a positive NPV investment. Conversely, if the owner will not sell for less than $565,000, the purchaser will not buy the store, as the investment presents a negative NPV and therefore will reduce the overall value of the clothing company.
Related Terms:
• Discounted Cash Flow—DCF
• Discount Rate
• Payback Period
• Present Value—PV
• Time Value of Money
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