What is Net Present Value (NPV)?
Net Present Value (NPV) is the current value of a future stream of cash flows discounted at a chosen rate. It is calculated by summing each future cash flow divided by (1 + discount rate)^year. A positive NPV means the project earns more than the discount rate; a negative NPV means it earns less, on a discounted basis.
Detailed definition
Net Present Value is the cornerstone of corporate finance investment analysis. It captures the time value of money: a dollar tomorrow is worth less than a dollar today because today's dollar can be invested. By discounting all future cash flows back to today, NPV puts every project on the same time-zero footing for comparison.
The math is mechanical. Take each year's expected cash flow (positive for inflows, negative for outflows), divide by (1 + discount rate) raised to the power of the year, and sum across all years including year zero. Year-zero is the initial investment, usually negative. If the sum is positive, the project earns more than the discount rate; if negative, it earns less. The result is in today's dollars, which lets you add or compare NPV figures across different projects without rescaling.
NPV was first formalised in Irving Fisher's 1907 work "The Rate of Interest" and then turned into a textbook capital-budgeting rule in the 1950s by Joel Dean, Franco Modigliani, and Merton Miller. Today it is the single decision rule most consistent with shareholder-value maximisation: of two mutually exclusive projects, the one with the higher NPV creates more absolute value, even if IRR or payback period rank them differently.
The discount rate choice is the most consequential input. For a 2026 US corporate project, the weighted average cost of capital (WACC) typically lands in the 8% to 10% range, derived from a 10-year Treasury yield of about 4.2% plus a 4% to 5% equity risk premium and adjusted for the project's debt-equity mix. For an individual evaluating a real-estate or business opportunity, it is the required return, often 8% to 12%. Safe-withdrawal-rate retirement work uses a 5% real discount rate to back-test the 4% rule. A small change in discount rate can flip a positive NPV negative, so sensitivity analysis (one-way tornado tables across plausible rates) is essential.
Formula
NPV = Sum from t=0 to n of (Cash Flow_t / (1 + r)^t)
- Cash Flow_t = Cash flow in year t (initial investment is typically negative)
- r = Discount rate (decimal, e.g., 0.10 for 10%)
- t = Year (0, 1, 2, ..., n)
- n = Number of years in the project
Worked example
Suppose you invest $100,000 in a project that pays back $30,000 per year for 5 years. Your discount rate (required return) is 10%.
- Year 0 cash flow: -$100,000 (initial investment)
- Year 1 PV: $30,000 / 1.10: $27,273
- Year 2 PV: $30,000 / 1.10^2: $24,793
- Year 3-5 PVs: $22,539 + $20,490 + $18,628
- Sum of all PVs: -$100,000 + $113,723 = $13,723
Related terms
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Frequently asked questions
What is Net Present Value?
Net Present Value (NPV) is the current value of a stream of future cash flows discounted at a chosen rate. It captures the time value of money: future cash is worth less than present cash because present cash can be invested.
What does positive NPV mean?
Positive NPV means the project's cash flows discounted at your required rate of return exceed the initial investment. Economically, the project beats your alternative use of capital. Accept the project.
What does negative NPV mean?
Negative NPV means the project does not earn back its initial investment at your discount rate. Economically, you have better alternatives for your capital. Reject the project.
How do I choose a discount rate?
Corporations use Weighted Average Cost of Capital (WACC). Individuals use their required rate of return, often 8% to 12% for moderate-risk investments. Higher risk projects need higher discount rates.
What is the relationship between NPV and IRR?
IRR is the discount rate that makes NPV exactly zero. NPV at your required rate tells you if the project beats it; IRR tells you the project's own intrinsic return. They are two views of the same cash flows.
Can NPV be used for personal financial decisions?
Yes. Real estate purchases, refinancing decisions, taking a job with stock options, paying down debt vs investing - all involve future cash flows that can be discounted to today using NPV to compare alternatives.
What discount rate do practitioners use in 2026?
US corporate finance teams use a WACC of 8% to 10% for typical 2026 capital projects, anchored to a 10-year Treasury yield near 4.2% plus a 4% to 5% equity risk premium. Safe-withdrawal-rate retirement work uses a real 5% discount rate. Infrastructure and utility projects sit at the lower bound (6% to 7%) because of stable, regulated cash flows; venture and growth investments use 15% to 25%.
How sensitive is NPV to the discount rate?
Very. On the worked example (5-year, $30K annual cash flow, $100K initial), NPV is $13,723 at 10%, $4,289 at 14%, and -$4,156 at 18%. A four-point change in discount rate flips the project from clearly profitable to clearly unprofitable, which is why every NPV model should include a one-way sensitivity table or tornado chart.