Legal Definitions - NPV

NPV stands for net present value. It is a financial term used to evaluate the investment potential of a project. It is calculated by finding the present value of net cash flow from a project and then discounting it by the cost of capital.

• If a company invests $10,000 in a project and expects to receive $12,000 in net cash flow after one year, the NPV can be calculated by finding the present value of $12,000 and then subtracting the initial investment of $10,000. If the cost of capital is 5%, the present value of $12,000 is $11,428.57. Therefore, the NPV is $1,428.57.
• Another example could be a real estate investment. If an investor purchases a property for $200,000 and expects to receive rental income of $20,000 per year for 10 years, the NPV can be calculated by finding the present value of the rental income and then subtracting the initial investment. If the cost of capital is 8%, the present value of the rental income is $148,024. Therefore, the NPV is -$51,976, which means the investment is not profitable.

These examples illustrate how NPV is used to evaluate the profitability of an investment. A positive NPV indicates that the investment is profitable, while a negative NPV indicates that the investment is not profitable. It helps investors make informed decisions about whether to invest in a project or not.