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Net present value (NPV) tells you whether an investment creates or destroys value by comparing the present value of future cash flows to the upfront cost.
The formula
NPV = −Initial Investment + Σ [Cash Flow_t / (1 + r)^t]
Where r is the discount rate and t is the time period in years.
For a $100k investment at 10% discount rate with $30k, $35k, $40k, $40k, $40k annual cash flows: NPV = −100k + 30k/1.1 + 35k/1.21 + 40k/1.331 + 40k/1.464 + 40k/1.611 NPV = −100k + 27.3k + 28.9k + 30.0k + 27.3k + 24.8k = $38.3k
Positive NPV means the investment creates value above the required return.
NPV decision rules
| NPV | Decision |
|---|---|
| Positive (NPV > 0) | Accept — creates value above required return |
| Zero (NPV = 0) | Break-even — earns exactly required return |
| Negative (NPV < 0) | Reject — destroys value at this discount rate |
Profitability Index (PI)
PI = (NPV + Initial Investment) / Initial Investment
PI measures value created per dollar invested. PI > 1 = positive NPV. Useful for ranking competing projects when capital is constrained: higher PI means more value per dollar of capital deployed.
| PI | Interpretation |
|---|---|
| > 1.5 | Excellent return |
| 1.1–1.5 | Good return |
| 1.0–1.1 | Marginal return |
| < 1.0 | Destroys value |
Choosing the right discount rate
The discount rate is the most critical input — small changes have large effects.
Corporate WACC: Weighted average of debt cost (after-tax) and equity cost. Typical range: 8–12% for established businesses.
Venture/startup: Higher rates (20–30%) reflect higher risk. A startup might require 25% return to compensate investors for failure risk.
Hurdle rate: Many companies set a minimum acceptable IRR (15–20%) for projects to compete for capital allocation.
When uncertain, run NPV at multiple discount rates (sensitivity analysis).
NPV vs IRR
IRR (Internal Rate of Return) is the discount rate at which NPV = 0. Both measure project value; NPV is generally preferred because: - NPV is in dollar terms (easier to interpret) - IRR can give multiple values for unconventional cash flows - NPV correctly handles varying discount rates over time
Frequently asked questions
What does this calculator do? Calculate NPV from an initial investment and up to 5 years of cash flows. Enter your discount rate (cost of capital) and projected annual cash flows.