net present value
The difference between the present value of cash inflows and outflows over time, used to assess the profitability of an investment. Positive NPV means the investment adds value.
Example
“The project had a positive NPV of $200,000, meaning it was expected to add $200,000 in value after accounting for the cost of capital.”
Memory Tip
NPV positive = good investment. NPV negative = the cost outweighs the return.
Why It Matters
Net present value helps you make smarter investment decisions by showing whether a project or investment will actually make you richer in todays dollars. Rather than just looking at total profits, NPV accounts for the time value of money, meaning a dollar today is worth more than a dollar tomorrow, which is crucial for comparing investments fairly.
Common Misconception
Many people think NPV only cares about total profits, but it actually focuses on whether those profits are worth more than what you could earn elsewhere. Someone might reject a positive NPV investment thinking it does not make enough money, without realizing that positive NPV means it beats their alternative investment options.
In Practice
Imagine you invest $10,000 today in a project that returns $3,000 per year for 5 years, and you could otherwise earn 8 percent annually in the bank. After calculating the present value of those future $3,000 payments using 8 percent as your discount rate, you get approximately $11,986 in todays money. Since $11,986 minus your $10,000 investment equals a positive NPV of about $1,986, this investment is worth doing because it beats your bank alternative.
Etymology
NET (after subtraction) PRESENT VALUE — the net of all present values of cash flows.
Common Misspellings
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See Also
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