Term of the Day - 7 February 2024

Today’s Term is “Net Present Value (NPV)”.

Net Present Value (NPV) is a financial metric used to evaluate the profitability of an investment or project by comparing the present value of its expected cash inflows and outflows. It considers the time value of money, which states that a dollar received today is worth more than a dollar received in the future due to its potential earning capacity.

To calculate NPV, future cash flows associated with the investment are discounted back to their present value using a predetermined discount rate, typically the company's cost of capital or a required rate of return. The NPV is then obtained by subtracting the initial investment cost from the sum of the discounted cash flows.

A positive NPV indicates that the investment is expected to generate more cash inflows than outflows, thereby adding value to the company. A negative NPV suggests that the investment is unlikely to be profitable, as the present value of expected returns is insufficient to cover the initial investment cost.

NPV is a widely used tool in capital budgeting and investment decision-making, as it helps managers assess the financial viability and attractiveness of various investment opportunities. By comparing NPVs of different projects, businesses can prioritize investments that maximize shareholder value and contribute to long-term profitability.