Definition of Net Present Value
Net present value or NPV is the net value after deducting initial investment from the present value of free cash flows. NPV is used to assess that a project is worthwhile or not. The present value is calculated by multiplying the cash flow with the present value interest factor (PVIF). If the PVIF is calculated as follows:
Assume that a project that has an initial cost of $200000, and for the next 6 years the following cash flows are expected. If the interest rate is 10% the present value and NPV are calculated as follows.
|
Year |
Cash Flows |
PVIF @ 10% |
Present Value |
|
0 |
-200000 |
1 |
-200000 |
|
1 |
40000 |
0.909091 |
36363.64 |
|
2 |
45000 |
0.826446 |
37190.08 |
|
3 |
55000 |
0.751315 |
41322.31 |
|
4 |
24000 |
0.683013 |
16392.32 |
|
5 |
65000 |
0.620921 |
40359.89 |
|
6 |
70000 |
0.564474 |
39513.18 |
|
NPV= |
11141.42 |
Since the NPV is positive $11,141, this means that the project is worthwhile.
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