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Net Present Value (NPV)

This document defines Net Present Value (NPV) and explains how to calculate and interpret it. NPV is a financial metric used to evaluate investments by comparing the present value of expected cash inflows to expected cash outflows. A positive NPV means the investment is expected to be profitable, while a negative NPV means it will likely result in a loss. NPV analysis considers the timing of cash flows and discounts future amounts using a discount rate, which represents the required rate of return. Sensitivity analysis is also important since NPV relies on assumptions about cash flows and discount rates that may change.

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35 views9 pages

Net Present Value (NPV)

This document defines Net Present Value (NPV) and explains how to calculate and interpret it. NPV is a financial metric used to evaluate investments by comparing the present value of expected cash inflows to expected cash outflows. A positive NPV means the investment is expected to be profitable, while a negative NPV means it will likely result in a loss. NPV analysis considers the timing of cash flows and discounts future amounts using a discount rate, which represents the required rate of return. Sensitivity analysis is also important since NPV relies on assumptions about cash flows and discount rates that may change.

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Sanket Awari
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Net
Present
Value (NPV)
Explained!!
Samuel Correia
01 Definition
NPV stands for Net Present Value. It is a financial
metric used to evaluate the profitability of an
investment or project by comparing the present
value of its expected cash inflows with the present
value of its expected cash outflows. NPV helps
investors and businesses determine whether an
investment will generate a positive or negative
return over time, considering the time value of
money.

Samuel Correia
02 Calculation

Samuel Correia
03 Interpretation
A positive NPV indicates that the present value of the expected cash
inflows exceeds the present value of the expected cash outflows. In
other words, the investment is expected to generate a profit, and it is
considered financially attractive.
A negative NPV indicates that the present value of the expected cash
outflows exceeds the present value of the expected cash inflows. In
this case, the investment is not expected to generate a profit, and it
is considered financially unattractive.
A zero NPV indicates that the present value of the expected cash
inflows is equal to the present value of the expected cash outflows.
The investment is expected to break even, but it may not generate a
profit.

Samuel Correia
04 Discount Rate

The discount rate used in the NPV calculation


represents the opportunity cost of capital or the
minimum rate of return required by investors to
compensate them for the time value of money and
the risks associated with the investment.
The discount rate is typically based on the
company's cost of capital, which includes the cost
of debt and the cost of equity, or it may be based
on the investor's required rate of return.

Samuel Correia
05 Application
NPV is commonly used in capital budgeting and
investment decision-making to evaluate the financial
viability of projects, acquisitions, or investments.
It helps businesses and investors prioritize among
different investment opportunities by selecting those with
the highest positive NPV.
NPV analysis also considers the timing and uncertainty of
cash flows, as cash flows occurring earlier are typically
more valuable than those occurring later, and projects
with more uncertain cash flows may require a higher
discount rate.

Samuel Correia
Sensitivity
06 Analysis
Since NPV calculations rely on various assumptions,
including cash flow projections and discount rates,
sensitivity analysis is often performed to assess the
impact of changes in these assumptions on the
NPV.
Sensitivity analysis helps identify key drivers of NPV
and evaluate the robustness of investment
decisions under different scenarios.

Samuel Correia
07 Summary
In Summary, NPV is a fundamental financial
tool used to assess the profitability and
financial attractiveness of investments or
projects by comparing the present value of
expected cash inflows with the present
value of expected cash outflows,
considering the time value of money.

Samuel Correia
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