In finance, the net present value (NPV) or net present worth (NPW)^{[1]} of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows. In case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow (DCF) analysis, and is a standard method for using the time value of money to appraise longterm projects. Used for capital budgeting, and widely throughout economics, finance, and accounting, it measures the excess or shortfall of cash flows, in present value terms, once financing charges are met.
The NPV of a sequence of cash flows takes as input the cash flows and a discount rate or discount curve and outputting a price; the converse process in DCF analysis, taking as input a sequence of cash flows and a price and inferring as output a discount rate (the discount rate which would yield the given price as NPV) is called the yield, and is more widely used in bond trading.
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Each cash inflow/outflow is discounted back to its present value (PV). Then they are summed. Therefore NPV is the sum of all terms , where
The result of this formula if multiplied with the Annual Net cash inflows and reduced by Initial Cash outlay will be the present value but in case where the cash flows are not equal in amount then the previous formula will be used to determine the present value of each cash flow separately. Any cash flow within 12 months will not be discounted for NPV purpose.^{[2]}
The rate used to discount future cash flows to their present values is a key variable of this process.
A firm's weighted average cost of capital (after tax) is often used, but many people believe that it is appropriate to use higher discount rates to adjust for risk for riskier projects or other factors. A variable discount rate with higher rates applied to cash flows occurring further along the time span might be used to reflect the yield curve premium for longterm debt.
Another approach to choosing the discount rate factor is to decide the rate which the capital needed for the project could return if invested in an alternative venture. If, for example, the capital required for Project A can earn five percent elsewhere, use this discount rate in the NPV calculation to allow a direct comparison to be made between Project A and the alternative. Related to this concept is to use the firm's Reinvestment Rate. Reinvestment rate can be defined as the rate of return for the firm's investments on average. When analyzing projects in a capital constrained environment, it may be appropriate to use the reinvestment rate rather than the firm's weighted average cost of capital as the discount factor. It reflects opportunity cost of investment, rather than the possibly lower cost of capital.
A NPV amount obtained using variable discount rates (if they are known for the duration of the investment) better reflects the real situation than that calculated from a constant discount rate for the entire investment duration. Refer to the tutorial article written by Samuel Baker^{[3]} for more detailed relationship between the NPV value and the discount rate.
For some professional investors, their investment funds are committed to target a specified rate of return. In such cases, that rate of return should be selected as the discount rate for the NPV calculation. In this way, a direct comparison can be made between the profitability of the project and the desired rate of return.
To some extent, the selection of the discount rate is dependent on the use to which it will be put. If the intent is simply to determine whether a project will add value to the company, using the firm's weighted average cost of capital may be appropriate. If trying to decide between alternative investments in order to maximize the value of the firm, the corporate reinvestment rate would probably be a better choice.
Using variable rates over time, or discounting "guaranteed" cash flows differently from "at risk" cash flows may be a superior methodology, but is seldom used in practice. Using the discount rate to adjust for risk is often difficult to do in practice (especially internationally), and is really difficult to do well. An alternative to using discount factor to adjust for risk is to explicitly correct the cash flows for the risk elements using rNPV or a similar method, then discount at the firm's rate.
NPV is an indicator of how much value an investment or project adds to the firm. With a particular project, if R_{t} is a positive value, the project is in the status of discounted cash inflow in the time of t. If R_{t} is a negative value, the project is in the status of discounted cash outflow in the time of t. Appropriately risked projects with a positive NPV could be accepted. This does not necessarily mean that they should be undertaken since NPV at the cost of capital may not account for opportunity cost, i.e. comparison with other available investments. In financial theory, if there is a choice between two mutually exclusive alternatives, the one yielding the higher NPV should be selected. The following sums up the NPVs in various situations.
If...  It means...  Then... 

NPV > 0  the investment would add value to the firm  the project may be accepted 
NPV < 0  the investment would subtract value from the firm  the project should be rejected 
NPV = 0  the investment would neither gain nor lose value for the firm  We should be indifferent in the decision whether to accept or reject the project. This project adds no monetary value. Decision should be based on other criteria, e.g. strategic positioning or other factors not explicitly included in the calculation. 
A corporation must decide whether to introduce a new product line. The new product will have startup costs, operational costs, and incoming cash flows over six years. This project will have an immediate (t=0) cash outflow of $100,000 (which might include machinery, and employee training costs). Other cash outflows for years 16 are expected to be $5,000 per year. Cash inflows are expected to be $30,000 each for years 16. All cash flows are aftertax, and there are no cash flows expected after year 6. The required rate of return is 10%. The present value (PV) can be calculated for each year:
Year  Cashflow  Present Value 

T=0  $100,000  
T=1  $22,727  
T=2  $20,661  
T=3  $18,783  
T=4  $17,075  
T=5  $15,523  
T=6  $14,112 
The sum of all these present values is the net present value, which equals $8,881.52. Since the NPV is greater than zero, it would be better to invest in the project than to do nothing, and the corporation should invest in this project if there is no alternative with a higher NPV.
The same example in Excel formulae:


More realistic problems would need to consider other factors, generally including the calculation of taxes, uneven cash flows, and salvage values as well as the availability of alternate investment opportunities.

Redirecting to Net present value
