Net present value
Net present value (NPV) is the sum of a project's discounted cash inflows minus its initial investment, using the firm's required rate of return. A positive NPV means the project adds value.
FrameworkDCF investment appraisal
See it move
A machine costing €50,000 generates €20,000 a year for three years, discounted at an 8% required return. The present value of those inflows totals €51,540. Subtracting the €50,000 initial investment leaves a net present value of €1,540 — positive, so the project earns more than its required return and should be accepted.
The formula
Variables
- Net cash flow in period t (€)
- Required rate of return (discount rate) (decimal)
- Period number (periods)
- Project life (periods)
- Initial investment (outlay at t = 0) (€)
Accept if NPV > 0; the project earns more than the required return and creates value.
Check yourself
A project requires an initial outlay of €50,000 and generates net cash inflows of €20,000 at the end of each of years 1, 2, and 3. The required return is 8%. What is the project's NPV, to the nearest euro? (PV factors at 8%: year 1 = 0.9259, year 2 = 0.8573, year 3 = 0.7938)