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The Net Present
Value (NPV) of an investment (project) is the difference between the sum
of the discounted cash flows which are expected from the investment and the
amount which is initially invested. It is a traditional valuation method (often for a
project) used in the Discounted Cash Flow
measurement methodology, whereby the following steps are undertaken:
1. calculation of
expected free cash flows (often per
per year) that result out of the investment
2. subtract /discount
for the cost of capital (an interest rate to adjust for time and risk)
The intermediate
result is called: Present Value.
3. subtract the
initial investments
The end result is
called: NPV.
So NPV is an amount that expresses how much value an investment will
result in. This is done by measuring all cash flows over time back towards
the current point in present time.
If the NPV method results in a positive amount, the project should be
undertaken.
Although NPV measurement is widely used for making investment decisions, a
disadvantage of NPV is that it does not account for
flexibility / uncertainty after the project decision. See
Real Options for more information
regarding dealing with this in valuation.
Book: S. David Young, Stephen F. O'Byrne - EVA and Value-Based Management:
A Practical Guide to Implementation - 
Book: Aswath Damodaran - Investment Valuation: Tools and Techniques for
Determining the Value of Any Asset -
Book: James R. Hitchner - Financial Valuation:
Applications and Models -
Compare with Net Present Value:
Internal Rate of Return |
Payback Period |
Cost-Benefit Analysis
More valuation methodologies
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