Finance · Quick Answer

What is net present value (NPV)?

NPV is the current value of future cash flows, discounted to today's dollars. NPV = Σ (Cash Flow_t / (1 + r)^t) − initial investment. Positive NPV means the investment beats the discount rate; negative means it doesn't.

The formula

NPV = Σ [CF_t / (1 + r)^t] − Initial Investment

Where:

CF_t = cash flow in period t
r = discount rate (often your cost of capital or required return)
t = time period

How to read the result

NPV > 0: the project earns more than your discount rate, accept
NPV = 0: breaks even vs. your required return
NPV < 0: the project underperforms your required return, reject

Example

Project costs $10,000 today, returns $4,000/year for 3 years. At a 10% discount rate:

Year 1: $4,000 / 1.10 = $3,636
Year 2: $4,000 / 1.21 = $3,306
Year 3: $4,000 / 1.331 = $3,005
PV of cash flows: $9,947
NPV: $9,947 − $10,000 = −$53

Marginally negative, this project barely misses the 10% hurdle.

Why the discount rate matters

The discount rate reflects opportunity cost. A higher hurdle rate (riskier projects, higher required return) shrinks future cash flows more aggressively, making NPV more negative.

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