Net Present Value (NPV) is a capital budgeting technique that calculates the present value of all future cash flows from an investment, discounted at a required rate of return, minus the initial investment. A positive NPV means the investment creates value; negative NPV means it destroys value.
NPV = Σ [Ct / (1 + r)^t] − C₀
Ct = cash flow at time t, r = discount rate (required rate of return), t = time period (year), C₀ = initial investment cost. Sum all discounted future cash flows then subtract the initial investment.
Example 1: Project costs $50,000 upfront. Expected cash flows: Year 1: $15,000, Year 2: $20,000, Year 3: $25,000, Year 4: $20,000. Discount rate: 10%
Result: NPV = $12,608 (Positive — the investment creates value)
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