What is Net Present Value (NPV) and how do you interpret it?

Intermediate

Answer

NPV is the sum of a project's discounted future cash flows minus the initial investment, using the required rate of return (cost of capital) as the discount rate. A positive NPV means the project earns more than the required return and adds value (accept); a negative NPV destroys value (reject). NPV is the theoretically preferred appraisal method.

NPV = -Investment + Σ [Cash flow_t / (1+r)^t].
Positive NPV -> accept.

Real-world example A project with a +$150k NPV at the 10% cost of capital is accepted because it creates value.

Common follow-ups: What decision rule applies to NPV? | What discount rate is used?

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