Net Present Value (NPV)
DE: Kapitalwert (NPV)
The difference between present value of cash inflows and outflows over time.
Detailed Explanation
NPV is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. It accounts for the time value of money — a euro today is worth more than a euro in the future because it can be invested to earn returns.
In project selection, NPV is used to evaluate and compare investment alternatives. A positive NPV means the project is expected to generate more value than it costs (accounting for time value); a negative NPV means it destroys value. Among competing projects, the one with the highest NPV is generally preferred.
NPV is calculated by discounting future cash flows to their present value using a discount rate (typically the organization's cost of capital or hurdle rate). The formula is: NPV = Sum of [Cash Flow_t / (1+r)^t] - Initial Investment, where r is the discount rate and t is the time period.
Key Points
- Accounts for time value of money
- Positive NPV = value creation; negative = value destruction
- Higher NPV is better when comparing project alternatives
- Discount rate is typically the organization's cost of capital
- Used alongside ROI, IRR, and payback period for project selection
- A key component of the business case
Practical Example
A company evaluates two projects. Project A: EUR 100K investment, EUR 40K annual returns for 4 years. Project B: EUR 150K investment, EUR 55K annual returns for 4 years. At 10% discount rate: NPV(A) = EUR 26.8K, NPV(B) = EUR 24.3K. Project A has the higher NPV and is preferred despite lower absolute returns, because it generates more value per euro invested.
Tips for Learning and Applying
Use a consistent discount rate across all project comparisons
Be conservative with future cash flow estimates — optimism bias is common
Consider NPV alongside other metrics (payback period, IRR) for a complete picture
Negative NPV projects should only proceed if there are strong strategic reasons
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