What is NPV or Net Present Value?
NPV or Net Present Value is a financial metric in capital budgeting that is used to evaluate whether a project or an investment is going to yield good return in future or not. It can be simply represented as the difference between the present value of cash inflows and the present value of cash outflows. In the long run a positive NPV value indicates good potential return over investment, while the negative NPV value means that the investment is likely to lose money. Sometimes NPV is also referred as NPW or Net Present Worth.
NPV Calculation Formula
For calculating NPV value using formula, you must already know the estimated value of discount rate (r), all cash flow (both positive and negative) and the total initial investment made by the company. The formula for calculating NPV is as follows:
Where in the above formula:
- N = total number of periods
- n = positive integer
- C = cash flow
- r = discount rate
- NPV = net present value
Calculate NPV with Example
Suppose a company wants to start a new manufacturing plant in the near future. The company is looking forward to invest a total sum of $100000 in its setup at the beginning, where the expected discount rate is 10 percent per-annum. This company has set its goal for 5 years and for these 5 years the cash flows are $10000, $20000, $30000, $40000, $50000 respectively. Let's calculate the NPV and also evaluate whether the company should pursue this decision or not.
The equation we have:
NPV = C1/(1+r) + C2/(1+r)2 + C3/(1+r)3 + C4/(1+r)4 + C5/(1+r)5 − initial investment
Let's apply all the known values in the NPV formula here.
NPV = 10000/(1+0.1) + 20000/(1+0.1)2 + 30000/(1+0.1)3 + 40000/(1+0.1)4 + 50000/(1+0.1)5 − 100000
NPV = 6525.88
The positive value of NPV suggests the investment is likely to return profit in the future. In this scenario the NPV is 6525.88, so it seems that the investment is likely to yield profit.
NPV Decision Rule
- If NPV > 0, then the company should accept the investment decision or project. The positive value of NPV is expected to increase the net worth of the company or its shareholders.
- If NPV < 0, the company is expected to lose money, so it shouldn't pursue that investment or project.
- If NPV = 0, this will neither increase nor decrease the value of the company or firm.
Drawbacks of NPV
The discount rates (r) used in the formula above are likely to vary over time. The slight increase or decrease in discount rate can impact the NPV value. Hence it's critical in decision making.
NPV is not effective in comparing two mutually exclusive projects which require different amount of investment.
NPV may not give correct decision when comparing two projects with different time duration.
NPV calculation is based upon assumptions. It's prone to forecasting error. So, companies can't rely on only NPV before making any investment decision. There are other financial tools too (like IRR or Internal Rate of Return) which companies should consider for getting the clear picture.
Further Reading Suggestions:
- NPV vs IRR: Which is better for capital budgeting?
- NPV calculation in Excel
About this NPV Calculator
Calculating NPV can be a very daunting task, specially when you have so many positive and negative cash flows. There are many tools available that can be used to calculate NPV. You can either use financial calculators like Ti-83, Ti-84 and HP 12c calculator or can take the help from software like MS Excel. This website, npvcalculator.info, is such a tool. It's an online NPV calculator.
To calculate NPV or Net Present Value, enter the initial investment, the expected discount rate and the cash flows for each period. The calculator handles two kinds of projects: use Irregular cash flows when the amount differs from period to period, or switch to Regular cash flows when the same fixed amount repeats every period — such as a rent, an annuity, a lease or a subscription. Then hit the calculate button to get the NPV result.
How to Use This NPV Calculator
Getting your Net Present Value takes just four steps. Fill in the form at the top of the page with your own figures — here is exactly what each field means, followed by fully worked examples for both cash-flow types that you can copy.
The money you put in today (period 0). Type it as a positive number — the calculator
treats it as an outflow for you. Example: 10000.
Your required annual return or cost of capital, as a percentage. Enter 8 for
8% a year — not 0.08.
Use the toggle to pick how your returns behave. Irregular cash flows (the default) is for projects whose amount changes from one period to the next. Regular cash flows is for a fixed amount that repeats every period — like a rent, lease, annuity or subscription — so you enter it only once.
In Irregular mode, type the net cash for each period end and use + Add Period / − Delete Period to match your project's length. In Regular mode, enter the fixed Cash Flow per Period and the Number of Periods. In either case money coming in is positive and money going out is negative. Then press Calculate NPV.
Worked example 1 — irregular cash flows (a 4-year project)
| Form field | What to type |
|---|---|
| Cash-flow type | Irregular |
| Initial Investment | 10000 |
| Discount Rate (% p.a.) | 8 |
| Cash Flow — Period 1 | 5000 |
| Cash Flow — Period 2 | −2000 |
| Cash Flow — Period 3 | 6000 |
| Cash Flow — Period 4 | 6000 |
Period 2 is a negative cash flow (say, a year with extra costs) — enter it with a minus sign. Even so the NPV is positive, so the project is still expected to add value. A negative NPV would suggest it may lose money.
Worked example 2 — regular cash flows (a fixed $3,000 a year)
| Form field | What to type |
|---|---|
| Cash-flow type | Regular |
| Initial Investment | 10000 |
| Discount Rate (% p.a.) | 8 |
| Cash Flow per Period | 3000 |
| Number of Periods | 5 |
The same $3,000 arrives at the end of each of the 5 years, so you enter it once instead of five times. The calculator applies it to every period for you. The positive NPV means this level-income investment is expected to add value at an 8% required return.
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