NET PRESENT VALUE

It consists in bringing to present value the future cash flows of the investment project, discounted using a certain interest rate (“the discount rate”), and comparing them to the initial amount of the investment. As the discount rate, it is normally used the weighted average cost of capital (wacc) of the company which makes the investment.

NPV = – A + [ CF1 / (1+r)^1 ] + [ CF2 / (1+r)^2 ]+…+ [CFn / (1+r)^n ]

Whereas:

A: Initial investment.
CF: Cash flows.
n: Number of years (1,2,…,n).
r: Discount rate.
1/(1+r)^n: Discounting factor for an specific interest rate and number of years.
CFd.: Discounted cash flows.

If NPV> 0: the project is profitable.
If NPV< 0: the project is not profitable.

By the time of selecting between two projects, we will select the one with a higher NPV.
This method is considered as the best to analyze the profitability of a project.

Example of NPV calculation: