NPV is an investment term that describes the present value of an investment in future cash flows. The present value is determined by calculating the discount rate and the time interval between now and the cash flow. In other words, NPV accounts for the time value of money. For example, if a business invested in an asset in the future, the present value of that asset will be less than its future cash value.
NPV is more commonly used by public companies and businesses with large amounts of capital and certain cash flows. NPV can also be used by successful small firms that are successful at generating revenue and cash, but have high hurdle rates. As a result, they may turn down a project that would earn more than the cost of capital.
While NPV can help you determine whether a project is profitable, it’s not the only factor that matters. The time value of money can also impact the decision. A project that is generating a negative NPV might still be a worthwhile investment if it has the potential to generate more money in the future.
To calculate the NPV of an investment, you must first determine the cash flows of the two different projects. For example, if you invest $35,000 in Project X, you can expect to generate revenues of $10 in the first year, $27,000 in the second year, and $19,000 in the third year. Using an NPV calculator, you can calculate the NPV for each of the two projects. You can then compare the two projects to determine which is more profitable.