Short Definition: Net Present Value (NPV) is a financial metric that calculates the present value of a series of future cash flows, discounted at a specific rate.
Explanation: NPV is used to evaluate the profitability of an investment or project. It takes into account the time value of money by discounting future cash flows back to their present value. A positive NPV indicates that an investment is expected to be profitable, while a negative NPV suggests it may not be.
Example: If a project requires an initial investment of $100,000 and is expected to generate cash flows of $30,000 per year for five years, the NPV can be calculated by discounting each of those future cash flows back to their present value and then subtracting the initial investment.
Additional information (optional): NPV is a powerful tool for comparing different investment options, as it allows for direct comparison of their potential profitability, regardless of their timing or size. However, the accuracy of NPV calculations depends on the accuracy of the cash flow projections and the chosen discount rate.