Net present value (NPV)
Principles of Finance glossary · Capital Budgeting
Definition
The present value of a project's expected incremental free cash flows minus the initial investment, discounted at a risk-appropriate rate: NPV = -C_0 + sum_t=1^n CF_t / (1+r)^t. Decision rule: accept if NPV > 0. The gold-standard capital-budgeting metric because it measures absolute wealth creation.
Net present value (NPV) in plain English
NPV answers the most important question in business: 'If I spend money on this project, will I end up richer, and by how much in today's dollars?' The trick is that a dollar arriving next year is worth less than a dollar today (you could invest today's dollar meanwhile), so you shrink each future cash flow back to its present value before adding it all up and subtracting what you paid up front. In the formula NPV = -C_0 + sum_t=1^n CF_t / (1+r)^t, C_0 is the upfront cost, each CF_t is the cash you get in year t, and r is the yearly rate that penalizes waiting and risk. If the total comes out positive, the project creates real wealth and you do it; if negative, it destroys value and you pass.
Also called: NPV
Learn these first
Related Principles of Finance terms
Principles of Finance practice questions · Principles of Finance flashcards · Principles of Finance study guide