Business, Legal & Accounting Glossary
Net present value (NPV) is a method for evaluating the profitability of an investment or project.
The net present value of an investment is the present (discounted) value of cash inflows minus the present value of cash outflows. Here’s an example of net present value: Suppose an investment requires an initial cash outflow of $5,000 and provides cash inflows of $4,000 in year 1 and $3,000 in year 2. Without using net present value, simply toting up the cash flows sums to +$2,000 (-$5,000+4,000+3,000). With net present value and setting the discount rate to 10%, the investment is worth $1,115.70. (Net present value can be calculated using the NPV function in Excel.) By recognizing the time value of money and equating dollars from different years, net present value makes it possible to evaluate long-term investments. Accurately estimating the cash inflows and outflows for the net present value calculation is tricky; selecting an appropriate discount rate for net present value is also difficult. Nevertheless, net present value is a valuable tool for analyzing capital projects and other investments.
NPV or net present value can be obtained by subtracting the present value of cash outflows from the present value of cash inflows. It is used for analyzing the profitability of a project or investment in capital budgeting. A project can be undertaken if the result of NPV is positive. Net present value is susceptible to the consistency of the yield of future cash inflows of an investment or project.
The formula for calculation of NPV is: NPV = ∑t = 1T Ct / (1+ r) t − C0
The economic value of equity or EVE is a cash flow calculation. It is obtained by taking all asset cash flows at present value and subtracting liability cash flows at present value. The economic value of equity is practised by banks for asset and liability management.
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This glossary post was last updated: 27th March, 2020