Net Present Value

The present value of the difference between the cash inflow to the cash outflow is called Net present value. Net present value is usually calculated for investment returns that might take place in the future. It is one of the capital budgeting techniques adopted mostly in bigger companies while making investment decisions.  Net present value is important in decision making and to find out which investment is better from a pool of investment options available.

It is given by the formula

Where NPV is Net present value, C_t is the net cash flow (i.e. difference between cash inflow and cash outflow), r is the discount rate, t gives the time period of the cash flow.

Net present value calculates the current value of the asset in the future taking into account the inflation and interest rate. If the calculated net present value is positive then it must be accepted else it must be rejected as the cash flow will also be negative. If the net present value is zero then it means the project return backs the investment and the rate of return expected. The net present value is not usually calculated for small investment as it is ineffective in small investments.

The NPV method do have some disadvantage as well, some of the disadvantages are,

• They don’t consider other factors that can influence the cash flow.
• It does not include the uncertainty in the project.
• It does not include the risk factor associated with the project.
• It does not factor in opportunity cost into it.
•  It does not factor in intangible benefit associated with the business.