Net Present Value (NPV) Calculator
Calculate the present value of future cash flows to evaluate investment profitability
NPV Formula
Understanding Net Present Value
Net Present Value (NPV) is a core financial metric used to evaluate the profitability of an investment or project. It calculates the difference between the present value of cash inflows and the present value of cash outflows over a period of time. The fundamental principle is that money today is worth more than the same amount in the future due to its earning potential.
NPV accounts for the time value of money by discounting future cash flows back to their present value using a discount rate. This rate typically reflects the cost of capital or the required rate of return. A positive NPV indicates the investment should generate more than the minimum required return.
Capital budgeting decisions, investment analysis, and project evaluation all rely heavily on NPV analysis. It's considered one of the most reliable methods for making investment decisions because it accounts for both the magnitude and timing of cash flows.
NPV Decision Rules
Positive NPV
Accept the investment. It generates returns above the required rate and creates value.
Negative NPV
Reject the investment. It fails to meet the required return and destroys value.
Zero NPV
Indifferent. The investment exactly meets the required return - no value created or destroyed.
Comparing Projects
When mutually exclusive, choose the highest positive NPV. It creates the most value.
Choosing the Right Discount Rate
The discount rate is crucial to NPV calculation. Different rates can lead to dramatically different conclusions about an investment.
| Rate Type | When to Use | Typical Range | Notes |
|---|---|---|---|
| WACC | Corporate projects | 6-12% | Most common for businesses |
| Cost of Equity | Equity-funded only | 8-15% | Higher risk = higher rate |
| Hurdle Rate | Internal targets | 10-20% | Company-specific threshold |
| Risk-Free + Premium | Risk adjustment | Treasury + risk | Add premium for project risk |
| Opportunity Cost | Alternative investments | Best alternative return | What else could you earn? |
| Inflation Rate | Real vs nominal | 2-4% | Adjust for purchasing power |
Common NPV Mistakes to Avoid
Ignoring Opportunity Costs
Include the best alternative use of resources. If you're using existing equipment, include what you could earn by selling or renting it.
Wrong Discount Rate
Using a rate too low overvalues projects. Too high undervalues them. Match the rate to the project's actual risk profile.
Overly Optimistic Cash Flows
Be realistic about future cash flows. Consider multiple scenarios and use probability-weighted estimates for better accuracy.
Forgetting Working Capital
Projects often require inventory and receivables investment. Include initial working capital needs and recovery at project end.
Frequently Asked Questions
What's the difference between NPV and IRR?
NPV gives a dollar value of wealth created, while IRR gives a percentage return. NPV is generally preferred because it shows actual value creation, handles reinvestment assumptions better, and works for all cash flow patterns.
How do I handle inflation in NPV?
Be consistent: use real cash flows with a real discount rate, or nominal cash flows with a nominal rate. Mixing them gives incorrect results. Real analysis removes inflation from both cash flows and the discount rate.
Should I include sunk costs in NPV?
No. Sunk costs are already spent regardless of the investment decision. Only include incremental cash flows that will occur if you proceed versus if you don't. Past expenses are irrelevant.
What if NPV is close to zero?
A near-zero NPV means the investment barely meets your required return. Consider qualitative factors, strategic value, and whether your assumptions might be too optimistic. Small changes in assumptions could flip the decision.
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